May 15th Filing Deadline Draws Close

As May 15th draws near next week, I want to remind our nonprofit organizations of two important deadlines. 

Forms 990, 990-EZ & 990-N
For calendar year returns, Forms 990 and 990-T need to be filed by the 15th or properly extended.  If an organization is extending Form 990-T, then it should deposit via EFTPS any tax that is due with the return to avoid late payment penalties and related interest. If the organization has less than $50,000 of gross income and less than $200,000 in fixed assets, it should file its Form 990-N by May 15th.

Form 5578
Another deadline often overlooked is the deadline for private schools that do not file Form 990 or Form 990-EZ to file Form 5578.  Form 5578, Annual Certification of Racial Nondiscrimination for a Private School Exempt from Federal Income Tax is also due by May 15th for schools with a calendar year end.  This return is generally required to be filed by churches that operate schools as a direct part of their activities or by church affiliated schools that do not have a Form 990 filing requirement. 

The Form 5578 certifies that the school (church) has satisfied the applicable nondiscrimination requirements as detailed in Revenue Procedure 75-50.  In general these requirements are:

1. The governing documents contain the proper prohibition against discriminating as to admission or employment on any of the protected grounds other than based on religious discrimination;
2. The school's handbook and other documents should also contain similar language;
3. The school maintains records that indicate the racial make up of the student body, teaching faculty and administrative faculty; and
4. The school/church has publicized its nondiscrimination policy using either the appropriate radio or televsion medium.  (Internet does not qualify to meet this requirement.)  There are some exceptions to this rule, but they are very narrow and do not apply to many church operated schools. 

Form 5578 may be downloaded from the IRS website at www.irs.gov. Failure to file can result in an IRS inquiry and failure to comply with Revenue Procedure 75-50 can result in revocation of the school's tax exempt status. 

Want To Buy A Raffle Ticket?

When the Form 990 was redesigned in 2008, the form was rewritten to gain additional information regarding an organization's gaming activities.  Gaming activities have to be separately reported in Part VIII of the form and in some instances, greater detail is required through Schedule G associated with the return. 

With this additional information required, we are finding that many organizations are conducting some sort of gaming activity that previously was buried as a part of a fundraiser, such as a gala, dinner or golf tournament.  What most organizations do not realize is that state laws always govern any type of gaming activity.  While most people understand that state laws may regulate professional gaming activities, they fail to realize that state laws also regulate gaming activity that is carried out as a part of a fun filled event conducted by a nonprofit organization or a church. 

At this point, I will apologize to all of my followers that are not from Texas.  I have been asked to specifically blog the Texas rules for raffles.  Realizing that some of my readers are from other states, I encourage everyone to do a little digging and determine how your state may be regulating raffles and determine if your organization is in compliance with the applicable state statutes.

In 1999, Texas passed The Charitable Raffle Enabling Act that allows for charitable raffles to be conducted by qualifying organizations.  However, there are strict rules to be followed, if an organization desires its raffle to be covered by the act.

What Is A Raffle
In general, a raffle occurs any time someone pays for the chance to win a prize. Qualifying organizations are allowed to conduct two raffles each year that comply with the state law. 

Who Can Conduct a Raffle In Texas
An organization has to be a qualified organization:

• An association organized primarily for religious purposes that has been in existence for 10 years;
• A voluntary EMS that does not pay its members;
• A volunteer fire department that does not pay its members; and
• A nonprofit organization that:
• is at least three years old;
• elects its governing body;
• has 501(c) tax exemption;
• has members;
• does not distribute its income to its members; and
• does not participate in political campaigns.

Any other organization is prohibited from conducting a raffle in Texas.

What Must the Organzation Do
The qualifying organization must follow a few rules:

1. They must have possession of the prizes that are offered.
2. Prizes may not be cash or items converted to cash.  (It is thought that this does not prohibit gift cards as long as they cannot be readily converted to cash.)
3. If the organization purchases the prize, its value cannot exceed $50,000.
4. It must print tickets that include the name & address of the organization, the price of the ticket, the date the prize will be awarded and a general description of each prize that is valued at more than $10.
5. Tickets may only be sold by members or authorized representatives.  They may not be sold by compensated staff.  You also cannot pay someone to plan and conduct the raffle.
6. The raffle cannot be advertised statewide or through paid advertisements.  This means that it cannot be advertised on the organization's website as this would be considered as "state wide."

Penalties & Enforcement
Conducting an illegal raffle is issue for the organization's local district attorney.  It is a Class A misdemeanor for conducting an illegal raffle and a Class C misdemeanor for participating in one.  This means that the people actually conducting the raffle are at risk and should take seriously the above rules.

In essence, an organization cannot have an unplanned raffle or a spur of the moment raffle.  Complying with the above rules take care and consideration.  Therefore, organizations and churches should prepare policies and procedures to guide any type of activity that can be construed as a "raffle". 

IRS Expands Worker Reclassification Program

As if the IRS hasn't already given a huge gift to employers with the creation of the worker reclassification program in 2011, it has now topped off that gift with a big red bow. 

In 2011, the IRS provided a means to allow employers to reclassify workers from independent contractors to employees in a fairly simple process with a very low cost.  The effective cost was approximately 1% of the worker's compensation in the year previous to the reclassification.  Compared to the fact that the traditional cost of reclassifying a worker was 10 to 15% of compensation for three years, the new program provided an easy and cost saving mechanism for solving worker classification issues.  (See my post in October of 2011 for the original details of the program.)  In December of 2012, the IRS expanded the program through Announcement 2012-45 and 2012-46. 

Announcement 2012-45 expands the program in the following manner:

Originally the program stated that if the employer was undergoing an IRS exam, it was not eligible for the program.  Now the employer will be eligible to participate in the program as long as the exam is not classified as an employment tax exam.  It also clarifies that an employer that is a part of a controlled group must look to the entire group of employers when determining this criteria.  Employers that are contesting a reclassification issue in court do not qualify for to participate in the program.  Also, an employer is still ineligible if it is going through a DOL exam or a state employment exam. 

Additionally, participation in the program no longer extends the statute of limitations on the Forms 941 that include the reclassification.  All employment returns will maintain their natural statute of limitations.

Announcement 2012-46 went on to temporarily expand the program in an even greater manner:

Under the original program, the employer has to have properly filed all Forms 1099-Misc for any workers that it desires to reclassify as employees.  If the employer failed to file the required forms in the previous 3 years, it is not eligible for the reclassification program.  The IRS has alleviated this requirement for persons who apply to the program through June 30, 2013.  This means that even if an employer did follow the law in reporting a worker as an independent contractor, it may still participate in the program through June 30, 2013.  The amount assessed in this settlement program is higher than the regular settlement program as it assesses an amount equal to approximately 3.2% of the compensation paid in the previous year.   There is a graduated penalty assessed for the nonfiling of the required Forms 1099-Misc.  In addition, the employer must file all outstanding Forms 1099-Misc for the past three years. 

This program is truly a gift to those employers who have misclassified workers.  It provides a clean slate going forward as opposed to a potentially large tax assessment for each of the past three years.  The IRS reports that nearly 1,000 employers have participated in the program to date.  However, from experience, I know there are many more employers that need to participate in this program.  If a church or nonprofit has fallen prey to bad employment classification habits, now is the time to break them and move forward into a new arena of better compliance as well as less monetary risk to the organization.

Compensation - The Final Step is a Two Step

1) Determine the required withholding on all forms of compensation and
2) Determine the proper reporting of all compensation and benefits.

I am finally completing this series.  I am to the step that most people are accustom to working with in order to do payroll.  While most organizations do complete this step in regards to cash compensation, few seem to complete it correctly in regards to noncash compensation.

Some items of noncash compensation are not subject to withholding while others are.  IRS Publications 15, 15A & 15B all deal with properly reporting compensation and fringe benefits.  Since we now know what items the organization is providing to its employees, it should be fairly easy to determine any withholding requirements.  (Remember that ministers are not subject to any mandatory withholding of federal income tax, so adding their benefits to payroll is fairly simple.  Also, ministers are not subject to FICA/Medicare, so this also simplifies this process for their compensation.)

If an organization is using a payroll service, then it is best to remember that its payroll reports are generally prepared very quickly at the end of the quarter or the end of the year.  Therefore, it is necessary to communicate with the service prior to the end of any reporting period.  Otherwise an organization may find that it is necessary to amend payroll reports that have already been submitted to the IRS and the Social Security Administration in order to properly report some items of compensation. 

Several items require special reporting on the Form W-2, so be specific about the benefits that are provided and review the instructions for preparing the Form W-2 each year.  For example, dependent care benefits are reported in a separate box on the Form W-2 even though the benefit is not taxable to the employee if provided through a qualifying plan. 

In summary, the number one area that can result in an IRS inquiry and/or in the assessment of monetary penalties is payroll reporting.  Therefore, each organization should review all payroll filings carefully to determine if the proper amount of tax has been paid and if all items of compensation have been properly reported.

Compensation Planning - Part 7 of ?

My apologies for the break in this series.  As we approached the April 17th filing deadline, I found that blogging rated way down on the list of activities that had to be performed.  Thank you for your patience in waiting for the next installment in this series.

Step 7:  What's Taxable

This is the most crucial step and is the one step that is often missed in properly reporting compensation.  There is some frustration within the IRS that the only taxable compensation reported is the compensation that physically flows through an organization's payroll system.  There is a tendency to ignore all the benefits and cash that do not flow through the payroll system.  The result is that income has a tendency to be underreported.  When an organization fails in its duty to properly report taxable income, it places its employees in serious jeopardy of potential penalties, additional taxes and even jail time. 

Basic Rule
Each element of the compensation package has to be evaluated to see if it is taxable.  Remember, that everything is taxable until a provision in the Internal Revenue Code says that it is not.  Therefore, it should be presumed that something is taxable until it can be proven that it is not taxable.

Remember, when determining taxability, it must be determined for purposes of federal income tax, social security tax (FICA) and Medicare tax, if the compensation is for a nonminister employee.  If for a minister, then the employer is only concerned about the taxability for purposes of federal income tax. 

Making Determinations by Comparison
One of the biggest dangers in this area is making the determination based on what someone else is doing.  You know how the story goes, Minister Joe goes to breakfast with all the other area ministers and returns with the information that over at First Church, Minister Steve has full childcare at their facilities and doesn't pay any tax on that benefit.  Based on this information, Minister Joe now requests that he be able to place his children in the church daycare center free of charge and the value of the benefit should not be taxable to him.

Cautions:

• get the correct facts; i.e., does Minister Steve know what is really taxable to him;
• don't assume that First Church is doing things correctly; i.e., it is possible for large and well established churches or organizations to not do things correctly; and
• look to see how First Church could be providing such a benefit tax free and then pursue that avenue.

Know the Hoops to Jump Through
There are many areas of the tax law that provide for tax free treatment of various fringe benefits.  However, almost all of them require certain actions taken by the employer to achieve this preferential status.  In the example above, First Church may have instituted a qualified dependent care plan.  Such a plan, when it meets a series of qualifications, provides for tax free dependent care.  Without meeting all the requirements, the benefit would be taxable to the emloyee.

Common Benefits Virtually Always Taxable
Cash - In any form, cash is virtually always taxable.  This includes anniversary/birthday gifts; love offerings; flat allowances; and gift cards.
Autos - Outside of a documented reimbursement at the standard mileage rate, any other benefit connected to an auto has a taxable component.  If the organization is actually providing the auto, there is always a taxable component.  These rules have been around since 1984.
Housing - Housing provided to employees who are not ministers is more likely than not taxable.  There are some exclusions, and they should be carefully considered.  If the employee is a minister, it is taxable unless it is specifically designated, in writing and in advance of payment, that it is provided under IRC Section 107 as a housing allowance or a parsonage.

Common Benefits that Normally Require Written Plans and Nondiscrimination Requirements
Life Insurance
Dependent Care
Tuition Assistance
Tuition Reduction
Payment of Out of Pocket Medical Costs
Retirement Plan Contributions (there are some exceptions for churches)

Summary
The above discussion is not an exhaustive study of potential taxable income.  This is the step in compensation planning that is generally left to the organization's bookkeeper, internal accountant and/or payroll service.  Therefore, it is greatly beneficial for the organization to build a relationship with a trusted tax professional that will provide a resource to assist personnel with these determinations.

Compensation Planning - Part 6 of ?

Step #7 - Properly Classify the Employees Who are Ministers

There is no special time during this process to complete this particular step, so I have chosen to place it in this slot. It is a crucial step in the process and must be completed at some point in time. Ministers have different tax treatment than other employees and this treatment is mandated by law. It isn't optional, so it is important to know who qualifies as a minister for federal tax purposes. (At this time we are only dealing with defining ministers for federal tax purposes and not for other purposes such as for Department of Labor purposes.)

Minister's Tax Status
Ministers have what is commonly referred to as "dual tax status".

Federal Tax Purposes: For federal income tax purposes, a minister is generally treated as a common law employee. Additionally, while he/she is subject to paying federal income tax, a minister is exempt from the mandatory withholding of the federal income tax.

Social Security/Medicare Tax Purposes: For payments into Social Security, the minister is always self employed. This translates into the fact that a minister can never pay into the Social Security/Medicare system the way a regular employee does through the traditional employee payment with an employer matching payment better known as FICA/Medicare. This is defined by law under IRC Section 1402 and 3121.

If you have a minister working for your organization and he/she is considered a minister for purposes of receiving a housing allowance and the minister is participating in the FICA/Medicare program through withholding and matching, this practice should be stopped immediately. The only way that a minister can pay into the Social Security/Medicare system is through the Self Employed Contributions Act by paying SE tax on his/her personal tax return.

Who is A Minister?
In order to be considered a minister for federal income tax purposes, the employee must have been commissioned, licensed or ordained by a church (credentials issued by organizations that are not churches do not qualify.) Additionally, the minister must be performing ministerial duties. For a church, ministerial duties include 1) the preaching, teaching and conducting of religious worship services; 2) the control, conduct & maintenance of a religious organization and their integral agencies; 3) the teaching and administration in a theological seminary; and 4) the performance of sacerdotal functions. If the employer is not a church, then ministerial duties are limited to #1 and #4.

Documentation
The employer needs to document the ministerial duties being performed by the minister as well as maintain copies of the credentials in the minister's personnel files.

Conclusion
This is a very brief explanation of this particular area and is simply discussed just to bring attention to the important differences attributable to ministers in the area of payroll. If an employer has any concerns about the proper classification of its ministers, it should seek advice from a competent tax professional.

Compensation Planning - Part 5 of ?

Step #4 - Value the Benefits

Last week we discussed identifying all of the benefits bestowed to an employee. This week we finally start to look at some numbers. Each of the benefits identified now has to have a value assigned to it. This may or may not be associated with the cost paid by the church for a benefit.

Example: First Church provides their senior pastor with a car. It pays all of the expenses associated with buying the car and maintaining the car. The Internal Revenue Regulations tell us explicitly how we should value the auto. The primary method uses what is called the annual lease value table. The assigned value from this table is used to value the car and it is not related to how much the church spends on the car during the year.

Some items are easy to value and some are more difficult. Some items have stated values, i.e., the value of a tuition discount granted to an employee at the school operated by the organization, while others require outside appraisers like may be needed to value housing provided by the organization.

It is imperative that the benefits be valued in order to complete Step #5.

Step #5 - Is It Too Much

Remember the earlier posts which discussed determining the "umbrella" of reasonable compensation. Now is the time to look to the umbrella. After all the elements of compensation are determined and then they are valued, the total value of the benefits provided has to be compared to the umbrella of reasonable compensation. If it doesn't fit under the umbrella, then something has to be cut or removed from the compensation package. If this exercise is performed as a part of the compensation planning at the beginning of the year, then there can be no surprises for the employee or the organization at the end of the year.

Step #6 - Write It Down

Once everything is defined, and it all fits within reasonable compensation, it is time to write it down. Compensation should be formally documented in a manner that is appropriate for the level of employee being compensated.

Example #1: A secretary may have her compensation approved and defined by one of the officers of the organization. The package would be written down, approved by the appropriate officer and then placed in the secretary's personnel file.

Example #2: The president of an organization is considered a disqualified person (see post on intermediate sanctions). His compensation package must be authorized by the appropriate governing body, i.e, the board of directors, the personnel committee, etc. and it must be writtten down in the minutes of the meeting where the compensation package is approved. Failure to formally document the compensation for a disqualified person can cause the entire package to be considered as not authorized for payment. Also remember that "documenting the compensation in writing" is one of the required steps in meeting the safe harbor test for excess benefit transactions and intermediate sanctions.

This post has covered three important steps in the compensation planning process. While it should be considered as mandatory for any employee that is considered to be a "disqualified person", it is a good practice for all employees.