5 Myths About Starting a Church, Part 2
By Raul Rivera
In the last article, we began a series to debunk five myths about starting a church. You read the allegorical story of John, a pastor with all of the passion and training to know how to spiritually lead a church, but lacking the knowledge needed to properly establish the legal foundation of his ministry.
This story is common for pastors all over the country. Due to the current climate of our nation, we cannot afford to be uninformed regarding the legal and financial tax law matters that affect our ministries. Let us continue our study to go over the three remaining myths about starting a church.
The myths
Myth #3 - “I have state sales or franchise tax exemption. That’s the same as getting 501(c)(3) approval from the IRS. There is no need to file Form 1023.”
State sales tax exemption is not the same as receiving federal 501(c)(3) tax-exempt status. The federal tax exemption for 501(c)(3) organizations allows them to receive donations that are tax-deductible to donors. These organizations are also exempt from paying federal income taxes. If you are applying for a grant for funding as a nonprofit, the granting organization will generally want to see the letter from the IRS approving your tax-exempt status.
Several states offer an exemption from sales tax for nonprofit organizations. The requirements vary state by state, however it is a great benefit to the nonprofits that qualify. Because sales tax is charged by state, these exemptions are only state level exemptions and are not at all controlled by the IRS. Such exemptions are very beneficial to your ministry, but did you know that many states base their requirements for sales and franchise tax exemption on the IRS guidelines for qualifying as a tax-exempt organization?
Most churches seek state sales tax exemption right away because it offers an immediate financial benefit. But do not forget that it is the IRS that has the ability to determine whether or not an organization is truly eligible to be considered a tax-exempt organization. This means that if the IRS revokes the tax-exempt status of your church or ministry, the state will be required to treat your church as a for-profit entity and you will no longer be eligible for the state benefits you enjoy as a nonprofit.
It is the fact that the IRS recognizes churches as charitable organizations that sets the precedence for states to allow exemptions from certain taxes.
Myth #4 - “I don’t get compensated by my church. They just give me love offerings from time to time to help my family financially. But this doesn’t count as compensation because it’s not a regular payment or a regular amount.”
Compensation is not considered income just because it is a regular amount or a regular payment. Compensation is a payment for services rendered. When a church determines to help out a pastor by making any payment towards living expenses, the main reason why the church is paying the pastor is because he/she is providing a valuable, vital service for the ministry and is deserving of that wage.
However, when a church pays a pastor without properly setting up a salary, there are grave consequences. In 1996, Congress authored section 4958 of the Internal Revenue Code, in an effort to combat fraud in many large and well-known nonprofit organizations. The law now imposes severe penalties (excise taxes) directly to board members, bishops, deacons, and others who exercise control or influence in the organization, if they engage in an abusive transaction. How does that affect you and your ministry?
If your church commits what is called an excess benefit transaction, according to section 4958, serious fines can be applied. An excess benefit transaction is any financial transaction where a disqualified person receives a benefit in excess of the value of consideration for services rendered. This means that if a board member, his/her family, or any person with substantial influence in the organization receives any payment not properly approved by the board of directors, this is a violation of the law and is susceptible to penalty taxes.
Well, cannot the pastor or his/her family receive benevolence? Unfortunately, no. Section 4958 disqualifies certain persons (“disqualified persons”) from receiving any financial benefits from the organization except for compensation for services rendered.
This means that any time you pay a pastor, you need to be sure to properly approve his/her compensation in a board meeting, along with a job description to show that there is a valid reason for compensating the pastor.
Myth #5- “If I apply for federal tax-exempt status, the government can control what I preach. If I do not file, they have no right to look into what my church does.”
This myth is perhaps the biggest one affecting churches today. Many believe that by filing for federal tax-exempt status, you are subjecting your ministry to the control of the federal government. This is not so, and this mistaken belief comes from a lack of understanding portions of federal tax law.
Section 508 of the Internal Revenue Code requires any organization wanting recognition as a federally tax-exempt charity to file Form 1023 with the IRS to obtain this exemption; however, section 508(c)(1)(A) exempts churches, associations of churches, and conventions of churches from filing this form. This does not mean, however, that churches are not required to meet the requirements of section 501(c)(3).
Those who believe that filing Form 1023 subjects them to the government’s control over what they preach from the pulpit are under the false impression that applying for 501(c)(3) status will make their church or ministry subject to the IRS. It is a matter of settled law that churches and ministries are subject to IRS regulation even in the absence of specific recognition of 501(c)(3) status. It is cemented by recent court rulings such as JACK LANE TAYLOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, and BRANCH MINISTRIES, INC. Petitioner v. CHARLES O. ROSSOTTI. These two cases establish two things.
- There is no provision in the law that grants a church immunity from meeting the requirements of section 501(c)(3) if that church or ministry wants to be tax-exempt.
- The presumption of tax-exempt status does not exist unless the church has been officially recognized by the IRS to meet the requirements of section 501(c)(3).
In the court case JACK LANE TAYLOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, the court states: “Nothing in section 508(c)(1) relieves a church from having to meet requirements of section 501(c)(3). In fact, it is clear that when the Commissioner determines that an organization is not entitled to an exemption as a church, as is the case for IBT, its contributors must prove the church’s right to an exemption under section 501(c)(3) in order to be entitled to a deduction for their contributions.”
This means that unless your church files for federal tax-exempt status, the burden of proving that you are properly organized as a tax-exempt organization falls squarely on each of your church member’s shoulders.
But what about the claim that the IRS can invade your church's freedom of religion, speech, and doctrinal teachings? This absolutely NOT TRUE. In fact, there is no law or regulation in existence that limits what ministers can preach from the pulpit. Even more so, the courts have upheld the church's right to free speech from the pulpit even when the IRS has attempted to regulate it. Despite these facts, there are some groups that teach the contrary by saying that any church that gets 501(c)(3) status must sign a waiver to forfeit their First Amendment Freedom of Speech rights. At best, they are mislead, and at worst, flat out dishonest.
In closing
If you have found yourself reading the 5 myths about starting a church and realize that you have believed them and based ministry decisions on them, do not be discouraged; get informed. At StartCHURCH, we offer a myriad of services and products to help you establish the best legal foundation for your ministry. From our StartRIGHT Service and services for minister’s salaries, we can help you start on track or get on track with the legal foundation of your ministry.