Monday, February 1, 2016

501(c)(4) Organizations Face New Reporting Requirements

Organizations claiming exemption under IRC Section 501(c)(4) have received greater attention over the past two years amidst allegations of IRS targeting based on an organization's political and/or philosophical views.  Due to what is perceived by many as widespread unacceptable activity by (c)(4) organizations, there are various attempts to increase the regulation and oversight of these organizations.  One of these attempts was recently codified into law as a part of the recently enacted Protecting Americans from Tax Hikes (PATH) legislation.  Organizations formed under 501(c)(4) are now required to file an additional notification with the IRS.


Unlike organizations organized under IRC Section 501(c)(3), organizations exempt under 501(c)(4) have the ability to operate as exempt organizations without receiving official notification of exempt status from the IRS.  These organizations are categorized as "self declarers".  The organizations have to follow the rules and file the required annual Form 990, but they do not have to file an application with the IRS to have their exempt status recognized.  An organization may file a Form 1024, Application for Recognition of Exemption under Section 501(a), if it wishes to receive IRS approval and receive a determination letter from the IRS.  

New Law

PATH has enacted IRC Section 506 requiring organizations formed under 501(c)(4) to notify the IRS of the intent to operate as a 501(c)(4) organization.  Notification must be made to the IRS within 60 days of the formation of an organization created after December 18, 2015.  Additionally, notification is required by any organization in existence at December 18, 2015 that has never filed either an exemption application, Form 1024, or an annual information return, Form 990, 990-EZ or 990-N.   The due date for notification by existing organizations is June 15, 2016.   Failure to comply with the notification requirements carries of penalty of $20 per day up to a maximum of $5,000.  

The notification includes 1) the name, address and employer identification number of the organization; 2) the state laws under which the organization was formed; 3) the date of the organization's formation; and 4) a statement of the purposes of the organization. (This notification is not a request for recognition of an organization's exempt status.  A request for determination of the organization's exempt status is required to be made in addition to the notification required under IRC Section 506.)

Extended Due Date

Due to the need for the IRS to issue regulations regarding the operation of the notification requirement, the due date for the notifications has been extended to 60 days after the issuance of the temporary regulations.  (Notice 2016-9)  Therefore, organizations are not required to provide notification at this time.  

Once this notification is fully operational, there will be very little time between an organization's date of formation and when failure to comply penalties begin to accrue.  Therefore, it is critical that professional working with and organizers of these organizations understand the substantial change  required by IRC Section 506.  The new requirement transforms an organization being able to operate as a self declared organization with no specific notification to the IRS of its existence, other than filing its annual return, to being required to immediately inform the IRS of its existence and purposes. 

Wednesday, January 20, 2016

Fringe Benefits - A Fresh Look to Start the New Year

It's a new year, so it's time to reevaluate everything your organization provides to its employees.  Each year my firm assists churches and other organizations in making payroll corrections to properly report the value of various benefits offered throughout the year.  To avoid making costly mistakes, it's time for a quick Fringe Benefit 101 update.

Fringe benefits are generally those items provided to employees outside of the normal paycheck.  Fringe benefits take on different shapes and different forms and can result in different tax treatments.  Many of them are paid directly by an organization, so they never come close to the organization's payroll system.  However, some are paid by employees through payroll tax deduction.  The IRS has expressed frustration with the omission of items of additional compensation involving benefits provided outside of the traditional paycheck system from being included in employees' income.

In reviewing fringe benefits, it is important to understand the basic premise of our tax system.  Under our taxing system:
  1. All items improving an employee are taxable to the employee until a tax provision can be identified to make it nontaxable;
  2. Most tax provisions affording tax free treatment of a benefit have rules that have to be followed; and 
  3. Not all benefits are treated the same for all applicable taxes.  For example, an employee's elective deferral into a retirement plan is excluded from federal income tax, but it is taxable for purposes of Social Security and Medicare taxes.
Mistakes in the proper treatment of fringe benefits can be costly in terms of payroll taxes and related penalties, but also in terms of an organization's tax exempt status.  Fringe benefits provided without the correct framework create private benefit or inurement of benefit and may threaten an organization's tax exempt status for both federal and state purposes.  Additionally, benefits provided incorrectly to organizational leaders or decision makers may constitute excess benefit transactions and subject individuals to intermediate sanctions requiring repayment of the benefit and penalties up to 225% payable to the IRS.

Since 2016 has just begun, it is a good time for a benefit review.  The review should include the following:

Step 1:  Take an inventory of any and all benefits provided to anyone in the organization even if the benefit is only provided to one staff member.   Look for those expenses that are paid directly for a staff member or allow a staff member to take advantage of one of the organization's services without charge or at a reduced charge.

Step 2:  Review the organizational minutes, budget, employment contracts, etc to confirm that any and all benefits have been properly authorized as additional compensation to the applicable staff member.   This step is crucial to avoid the creation of automatic excess benefit transactions under IRC Section 4958.  It is also necessary to confirm that a staff member's compensation is still within the realm of reasonable compensation.

Step 3:  Review the rules regarding the benefit to determine if the rules are being met.  Virtually every benefit that can be provided by an organization has a required framework to achieve tax favored treatment.  For example, the majority of benefits are required to be offered on a nondiscriminatory basis and cannot be offered just to those in upper management.  For churches, this requires a good review of any benefit exclusively offered to the ministerial staff members.

Step 4:  Determine the steps that need to be taken to bring the benefit into alignment with the rules.  If there is a plan already in place that appears to comply with the rules, have this plan reviewed every few years to determine if it is still in alignment with the rules.   This may require the assistance of either a CPA and/or an attorney.  When selecting these professionals always select those who are experienced in working with nonprofit organizations.  Churches should select professionals with specific experience working with churches, since some benefits afford special considerations for churches.

Step 5:  Review the reporting requirements for the benefit and determine the applicable taxes that may or may not be due. As previously mentioned, some benefits require special reporting and some are exempt from federal income tax but still subject to Social Security & Medicare taxes.

Step 6:  Document the results and make corrections in the payroll system to achieve the appropriate tax treatment.  It's only January, so make any payroll corrections now to avoid having to amend quarterly Forms 941 in the future.  Additionally, if a benefit is going to create taxable income to an employee, it is better to make that determination at the beginning of the year, rather than the end of the year.

The IRS provides Publication 15-B, An Employer's Tax Guide to Fringe Benefits, as a useful guide in evaluating benefits and related tax requirements and can be obtained at  Don't let your organization's benefit plans become an unexpected tax burden to either the organization or its employees,  Be proactive in protecting and benefiting both the organization and the employees with your 2016 benefit review.

Monday, January 11, 2016

Noncash Charitable Contributions - Not Just An Easy Deduction

(Note:  While the following post is focused on individuals more than charities, charities can learn from the woes of donors and make changes in practices and procedures to assist their donors in claiming noncash charitable contributions.)

We have all done it in the past - gathered up the old clothes and unused household items and delivered them to the charity of our choice.  If we are lucky, the charity's attendant hands us a "receipt" (I use this term loosely) for our donation.  We fill in the receipt as best we can and then add them to our tax information.  At tax time, we take them out and use them to determine our deduction for our noncash contributions (or worse hand them over to our tax preparer uncompleted, believing they have some intrinsic gift to know what was given and how much it was worth.)

Meet Mr. & Mrs. Kunkel (T.C. Memo 2015-71).  The Kunkels followed the above scenario to the amount of more than $37,000 of items donated to various charities.  The IRS audited the Kunkels and found that the substantiation for the noncash donations failed to meet the requirement of Internal Revenue Code Section 170 and disallowed the deductions.  The Kunkels took this position to court in hopes of achieving a more lenient decision from a judge.  The court was just as stringent as the IRS and also disallowed the deductions based on the following:

  • The Kunkels did not have any "contemporaneous written acknowledgements" from any of the charities;
  • In instances where a charity had picked up the donation from the Kunkels home and left the obligatory "thank you" receipt, the receipt was insufficient to justify a donation since it failed to contain any of the required information;
  • The Kunkels did not maintain a written record detailing each item that was donated, how it was acquired and it original price;
  • The Kunkels did not maintain any information on how the fair market value of the items was determined; and 
  • The Kunkels did not present any credible evidence that the items donated were "in good used condition or better."
There are several interesting lessons to be learned from this case:

  • The IRS may aggregate all the items donated into categories to determine if the requirement for an appraisal (value at more than $5,000) is met.  For example, out of all the donations, the Kunkels estimated that the clothing given away was valued at $8,000.  This was spread out among various charities, but the IRS aggregated the values and stated that an appraisal was required to claim the donation.  Other groups of items, i.e., household items or toys, were aggregated to determine if the additional substantiation requirements for donations of $500 or more were met.  This level of documentation requires the donor to keep records to describe and list each of the items donated, its original price when it was acquired and what condition it is in in addition to the date donated and the value at the time of donation.
  • Receipts, such as door hangers and blank receipts, often used by charities, do not meet the substantiation tests, since they are not donor specific, do not contain a description of the items donated and generally may not even be dated. 
  • Failure to claim deductions without the required substantiation may be considered as negligence and subject a donor to a 20% accuracy related penalty in addition to any additional taxes that are due.
Donors who desire a tax deduction for noncash contributions, including clothing and household items, should take great care to have records that contain all the required substantiation for the donation.  Charities, including churches, should become aware of the substantiation requirements, so they can assist donors by issuing receipts including all the required information.

A charities receipt should include:
  • The date the donation was received by the charity; 
  • The name and address of the donor;
  • A complete description of the items donated;
  • A general statement as to the condition of the items donated; and 
  • The "no goods or services" statement, as generally required for cash contributions. 
In addition to obtaining a qualifying receipt, donors must also be able to:
  • Maintain records establishing when or how the donated items were acquired and what the donor's cost basis is in the items;
  • Maintain records on how the fair market value of the items were determined by the donor;
  • Confirm that a receipt is always obtained and confirm that it is sufficient to meet the "contemporaneous written acknowledgment" when the aggregate of items donated is more than $250;
  • Understand when and how the appraisal requirements are applied with donations, either for an individual item or the aggregate of similar items, exceeding $5,000. 
There have been other cases of similar nature decided in the last few years.  The IRS is taking a strong stance on the substantiation of both cash and noncash charitable contributions and the courts are consistently siding with the IRS.  Both donors and charities need to be familiar with all of the requirements for substantiating charitable contributions.  Additional information on substantiation requirements can be found in IRS Publications 526, Charitable Contributions and 561, Determining the Value of Donated Property at

Friday, January 8, 2016

IRS Backs Off on Proposed Charitable Substantiation Procedures

The IRS continues to struggle with donors substantiating charitable contributions in the midst of advanced computer skills and capabilities or simply failures of donors to know, understand and adhere to the substantiation rules.  Contributions of $250 or more are required to be substantiated with a contemporaneous written acknowledgment that includes:

  • The amount of the cash donated or a description of the property donated (no value is required);
  • whether the donee provided any goods or services in consideration for the contribution, and if it did, a description and good faith estimate of the value of the goods or services provided; and 
  • if the goods or services consisted entirely of religious benefits, a statement to that effect.

Charities have struggled to implement the substantiation rules and include all the pertinent information.  Donors have struggled in understanding what is required substantiation and when they have to have substantiation, i.e., prior to the filing of a timely filed return.  The IRS has struggled with the ability of taxpayers to provide fraudulent receipts due to the wonders of electronic capabilities.  In an effort to provide for an avenue to resolve all of the failures, errors and frustrations, the IRS issued proposed regulations in September 2015 providing for the creation of a new IRS filing.  The filing would allow charities to report donors and related donations to the IRS in a manner similar to the current Form 1098-C used for reporting the donation of transportation equipment.  The filing would require the charity to report the donor's name, address and social security number as well as the amount of the donations.  The proposed filing was strictly optional, not mandatory.

  The IRS requested comments on the proposed regulations and received an overwhelming response.  Despite proposing an optional filing, many charities believed that the regulations were suggesting a mandatory filing requirement with the IRS.  Charities often strive to protect the identities of their donors and were concerned the proposed filing would unnecessarily provide their entire donor list to the IRS.  Additionally, there were concerns that charities choosing to utilize the filing option would not be able to provide adequate security over the social security numbers of the donors giving rise to concerns of potential identity theft.

Amidst the hue and outcry against the proposed regulations, the IRS attempted to placate the charity world by emphasizing the "optional" in the new regulations in a rare email communication issued early in December 20125.  However, concern over the proposed filing continued and in an action published January 8, 2016, the IRS has withdrawn the proposed regulations that would institute the new filing mechanism.

In the midst of all the discussion created by the IRS proposal, it is a great time to review the substantiation requirements and double check contribution receipts before they are issued this month.  Charities continue to struggle with the substantiation requirements resulting in donors forfeiting the right to deduct charitable contributions.  While the real burden to obtain adequate substantiation for one's charitable contributions lies with the donors, donors rely on charities to issue receipts that comply with the rules.

To assist donors, in the event of an IRS examination, contribution receipts reporting donations of $250 or more should include the following:

  • The name and address of the charity (including a logo or other unique identifier is not required but beneficial);
  • The date the receipt is issued (this is not required but is a prudent practice to assist donors in proving the receipt was timely provided to them);
  • The name and address of the donor;
  • A listing of the dates and the donation amounts (receipts for noncash donations would only list the date and a description of the item(s) donated);
  • In the event the donor is provided a product or service in exchange for the donation, the value of the product or service should be indicated; and 
  • Statement that there were no goods or service given in exchange for the contributions other than intangible religious benefits (if the charity is a religious organization).  (If goods or services have been given in exchange, this statement may be modified to indicate that the value has already been noted in the receipt.)
Donors should also be aware there is no mandatory deadline for when a charity has to issue contribution receipts.  Many charities and donors mistakenly believe contribution receipts have to be issued by January 31st each year.  While this may be a prudent business practice, it is not a legal requirement.  The donor is legally required to have the receipt in his/her possession either by April 15th or, if later, the filing date of his/her timely filed tax return.  

In summary, charities do not have to worry about a new filing requirement with the IRS, but they do have to worry about keeping their donors happy.  Reviewing contribution receipts for the above factors will make sure charities assists their donors in meeting all of their legal requirements in claiming charitable contributions. 

Wednesday, November 11, 2015

IRS Drives Home Rules Regarding Transactions With Foreign Entities

In recently released PLR 201539032, the IRS addressed the consequences of a U.S. nonprofit maintaining a poorly run foreign grant program.

Facts Presented
An organization was formed to provide financial support for a separate foreign organization as well as provide support for needy individuals, provide student stipends, support Jewish education and outreaches and provide room and board for students attending Jewish institutions.  During the process of applying for exempt status, the IRS initially determined that due to the specific support of a foreign organization, the organization could qualify as a tax exempt organization, but donations to it would not be deductible.  However, after agreeing to change its operations to not specifically support the foreign entity, the IRS agreed to allow the organization to receive tax deductible gifts.

Unfortunately the organization did provide support to a specific foreign organization and stated on its Form 990 its purpose was raising funds for the foreign organization.  Based on the information provided on Form 990, the IRS initiated inquiries as to the organization's foreign grant procedures.

Inquiries revealed the following:

  • The organization did not screen grant recipients through the Office of Foreign Asset Control Specially Designated Global Terrorist list to determine if the recipient was included on the watch list;
  • No application or other documentation was requested from the grantee;
  • Scholarships made directly to students were based on teacher recommendations;
  • No detailed description of any specific projects were required;
  • All of the grants were to persons connected with one particular organization;
  • All grants were intended for educational purposes, but no follow up was conducted to determine if those goals were being met;
  •  Students provided direct scholarships were not required to provide any proof of educational expenses;
  • The grants were approved by the board of directors, but always in the amount requested; 
  • The foreign organization did not provide any financial reports or accounting to the U.S. organization for any of its operations; 
  • There were no agreements that reflected the organization's discretion to withdraw funds in the event the charitable purposes were not met and no follow up evaluation was conducted; and
  • The organization's review of the effectiveness of the grants was limited to its on-site visits.

Legal Issues to Consider

Few U.S. organizations, including churches, realize the restrictions on supporting foreign organizations.  There are two primary issues that must be addressed in working with foreign individuals and foreign organizations;

  1. Tax Deductible Gifts;  U.S. tax law does not allow a U.S. taxpayer to deduct contributions to foreign organizations outside of limited exceptions with neighboring countries.   In the same manner, a U.S. organization that is merely a conduit or a fundraising organization for the foreign organization may operate as a tax exempt entity in the U.S., but its donors are not allowed to make tax deductible gifts to the U.S. organization.  In order for the U.S. organization to not operate as a conduit for the foreign organization, it must maintain control over its operations and its funds.  The IRS detailed examples of the application of these principles in Revenue Rulings 63-252 and 66-79.
  2. Private Benefit vs. Charitable Purposes:  A tax exempt entity must operate for its specific exempt purposes and not for private purposes.   Any activity that is not clearly documented to be an exempt activity is considered to be a private benefit activity or a nonexempt activity.  The existence of a single nonexempt purpose can destroy an organization's exemption. Better Business Bureau v. U.S. 34 AFTR 5 & American Campaign Academy v. Comm., 92 TC 1053
Expenditure Responsibility
If a U.S. organization is going to actively support a foreign organization and avoid being considered a conduit, then it must control over all funds provided to the foreign organization.   If a U.S. organization is going to provide support to a foreign organization or to an individual, it must be able to prove that assisting the recipient is an exempt purposes.   Both of these goals are addressed and met through a concept known as expenditure responsibility. (This private letter ruling describes the classic case of failing to meet both of these requirements.  The result was revocation of the organization's exempt status.  The IRS also noted that in the event the exempt status was retained, the organization would be considered a conduit and would not be able to receive tax deductible contributions.)

Expenditure responsibility isn't one set item or circumstance, but it is combination of several items indicating the U.S. organization is in control of the funds and is assured its funds are used for its charitable purposes.  If the funds are not being used for charitable purposes, then the presumption is they are being used for private purposes.  Items or actions that create expenditure responsibility may include, but are not limited to:

  • Predetermined grant requirements
  • Grant applications
  • Project budgets
  • Proof of actual expenditures
  • For scholarships, proof of fulfillment of educational requirements
  • Proof of financial need
  • Overall financial information of the organization
  • On-site visits by U.S. representatives
  • Direct accounting of expenditures
  • Compliance with anti-terrorism procedures
  • Personal involvement in project planning or fulfillment
  • Periodic reporting of a project's progress

Take A Ways from PLR 201539032
This ruling provides an excellent analysis of what the IRS expects from an organization to be able to address the two issues described above.  An organization actively operating in foreign countries should us this guidance to review its own policies and procedures to avoid any threat to its own exempt status.  Different organizations may have different specific ways to achieve expenditure responsibility, but the goal of an organization's grant making program should be to:

  • Know who is receiving the funds - Through applications, interviews and hands on knowledge, this information should be well documented.
  • Know the purposes for the funds - Require budget proposals or other financial information in the decision making process to allow for an educated decision as to the amount of funds to be made available.
  • Make clear the expectations - Grant recipients need to know what is expected out of them and the consequences of failing those expectations.
  • Know the end result of the funds - Don't assume the funds are used correctly, follow up to determine if the end result has been accomplished.
  • Avoid designated funds - Don't become a conduit for a well intended donor.  Refuse contributions earmarked for a foreign entity that is not participating in the organization's established foreign grant program.  Donations to foreign organizations and individuals are clearly not deductible if not controlled by the U.S. organization. 
Organizations filing Form 990 are required to disclose a synopsis of foreign grant making procedures on Schedule F.  A poor disclosure may lead to an IRS inquiry as it did in this ruling.  A church is still subject to all of these rules, but avoids the natural oversight that comes through the Form 990.  Therefore, it is important that churches realize the rules involved in foreign grant activity and build programs that will comply and protect the church's exempt status. If an organization's foreign grant program closely resembles the one described in PLR 201539032, then it is time to dust off those policies and procedures and take a fresh look at it.  Instituting changes may be difficult, but it is necessary to protect the organization's exempt status and the donors' tax deductible donations. 


Monday, August 18, 2014

Tax Court Sends Reminder of Documentation Rules

In a recently released decision, the Tax Court has reminded us of the importance of adequately documenting business expenses for mileage, travel and meals.  In Marcus O. Crawford, TC Memo 2014-156, the Court upheld the disallowance of Mr. Crawford’s business expenses for mileage, travel and meals due to inadequate documentation of the business purpose.  While the ruling deals with deductions claimed on Mr. Crawford's tax return, its theory applies to all documentation for these common expenses incurred by any church or nonprofit.  

Mr. Crawford operated a side business in addition to being a full time employee for another company.  The disallowed deductions related to his side business and were claimed on his Schedule C.  To support his deductions for mileage, meals and other travel expenses, Mr. Crawford provided his calendar with various notations as to places, names, activities or miles.  For his meals and entertainment expenses, he presented a spreadsheet indicating the place, the date, the amount and the business purpose.  (Sounds pretty good so far, right?) However, the IRS was not satisfied with the documentation and disallowed the expenses.  The Court and the IRS agreed on the following deficiencies:
  •  Documentation inaccurate:  Mr. Crawford's calendar proved to be inaccurate.  Entries on the calendar were in conflict with other independent documentation.  Since some of the entries were determined to be inaccurate, it was determined that none of the entries were reliable. 
  • Documentation vague or ambiguous:  Even if the calendar notations had been deemed reliable, the notations were determined to be too vague or ambiguous to support the business purposes.  The mileage entries did not clearly indicate the business purpose.  The Court refused to assume that the mileage notations were automatically associated with the business activities.  Other notations just listed someone's name with no other information to support the business activities. 
  • What was paid:  Invoices and confirmation print outs were presented to document travel expenses.  However, the Court could not determine if Mr. Crawford had paid for the expenses or if his employer had paid for the expenses or what were final expense amounts.  Once again challenging Mr. Crawford’s credibility, the IRS determined that some of the invoices had been paid for with a credit card that was reimbursed by Mr. Crawford’s employer. 
  • Lack of notated business purpose:  For receipts that were deemed credible, there was no business purpose noted on the receipt to clearly indicate the business purpose of the trip.
  • Business purpose too generic:  The spreadsheet presented to support the meal and entertainment expenses contained most of the required elements.  However, the business purpose was consistently listed as “interview/team training”.  Since some of the meals were only for Mr. Crawford, the documentation was suspect.  For those involving other people, the spreadsheet did not contain adequate documentation as to who was involved and the business relationship. 

In reviewing the Crawford case, I felt a certain déjà vu.  As a part of our IRS Compliance Reviews, we review expense reports as well as the documentation of a church/nonprofit organization’s credit card expenses.  We consistently find weaknesses in the documentation of these types of expenses.  Some of the weaknesses align with the Crawford case.  Consider the following:
  • Documentation vague, ambiguous or generic:   Use of the word “ministry” as the business purpose is not a sufficient business purpose and is as insufficient as Mr. Crawford’s “interview/team training”.   Another common one for churches is “hospitals” without any detail as to where the staff member actually traveled. 
  • Question as to what was paid:  Reservation confirmations are not always proof of an expenses.  Additionally, clarification of who has paid for an expense is vital to the reimbursement process.  Care needs to be taken to determine the actual payer of an expense prior to reimbursement by the church/organization and to reimburse for the final expense amount.   While normally not intentional, I have seen instances of expenses reimbursed that were originally charged on a corporate credit card. It is always a good practice to request original receipts be turned in for any reimbursement or for any credit card charge. 
  • Lack of any business purpose:  In regards to meals, just listing who was at the meal does not fulfill the documentation requirements.  The business connection of the person must be clearly established as well as the business purpose for the meal. 
  • Conflicting or unclear documentation:   It was determined that Mr. Crawford was reimbursed by his employer for some of the expenses that he claimed on his Schedule C. If a minister or other staff member is involved with a business or ministry outside the church, it is important to be able to determine the correct business associated with an expense. While the church or organization may gain an intangible benefit from a person's outside activities, it does not create a justification for the payment of the expenses of the outside business.  

Over time it is easy to fall into sloppy documentation habits.  Leaders of nonprofit organizations have many competing demands for their time and spending time documenting business expenses is tedious.  However, proper documentation of expenses is not only required by the tax law, it is critical to avoiding other undesirable consequences.  This is especially true of these three common expense areas.  In a separate blog post, we will review the consequences of poor expense documentation habits to both an organization and to the individuals involved.  In the meantime, it is time to review your organization's accountable expense reimbursement plan not only as it is written, but also as it is executed.  

Wednesday, March 5, 2014

Designating Housing Allowances - A "Must Do" Step for the Church

Ministers performing qualifying ministerial services may have a portion of their compensation designated as a housing allowance pursuant to Section 107(2) of the Internal Revenue Code.  (Terminology varies interchanging such words as housing, parsonage, rental or manse depending on the culture of the church.  The Internal Revenue Code and Regulations refer to it as "rental allowance".)  Within certain limitations, this portion of a minister's compensation is not subject to federal income tax. 

Internal Revenue Regulation 1.107(b) requires that in order to be "rental allowance", the amount must be designated as such pursuant to an official action taken in advance of the payment of the allowance by the employing church or other qualifying organization. Two cases decided in 2013 remind us of the critical need to properly designate housing or rental allowances.

In Ricky Williams v. Comm., pro se TC Summary Opinion 2013-60, the minister entered into an employment contract with his church.  The initial contract provided for a housing allowance for a period of six months.  Any provision extending beyond the six months would have to be formally decided at a later date.  The church never revisited this issue, so none of Reverend Williams' future compensation was designated as housing.  During an examination of his 2007 Form 1040, Rev. Williams asserted that over $33,000 of his compensation should be considered as housing allowance.  The IRS disagreed, so off to court they went.  The court ruled that Rev. Williams could not claim the housing allowance, since the church had never formally designated an amount as housing allowance after the initial six month provision.  Therefore, for 2007, no housing allowance existed.  Rev. Williams produced a new employment agreement dated in 2012 that included the housing allowance provision, but the court reiterated the requirement of having the designation prior to receiving the funds. The 2012 employment agreement was too little, too late.

In Donald L. Rogers, V. Comm., TC Memo 2013-177, Rev. Rogers' church paid his mortgage payments and utilities directly rather than pay him an allowance for the expenses.  Despite making the payments directly, the church failed to formally designate the payments as payments made pursuant to IRC Section 107.  Lacking the formal designation, the court agreed with the IRS that the payments represented taxable compensation to Reverend Rogers. 

Many churches are lax in their housing allowance designations.  I recommend that housing allowance designations be approved every year and be approved by either the appropriate committee, the board of directors or by a high ranking employee that has specifically been granted the authority to make the designations on behalf of the church or other qualified organization.  Remember the designation has to be done prior to the payment of the allowance, so beware of late designations or of designations that attempt to reclassify prior payments.  In this area, it pays to do it well and do it early in order to provide the maximum benefit to the minister.

Cautionary Note:  In Freedom From Religion Foundation, Inc. v. Lew, 112 AFTR 2d 2013-7107, the court ruled that IRC Section 107(2) is unconstitutional.  This ruling makes the housing allowance, but not the provision of a parsonage, unconstitutional.  The judge delayed the mandate for the IRS to enforce the ruling until the conclusion of the appeals process.  The government has appealed the decision to the 7th Circuit Court of Appeals.  Therefore, the future fate of this tax provision is in the hands of the U.S. Department of Justice and the 7th Circuit Court of Appeals.