Can the IRS Demand Church Records?

By Raul Rivera

When I speak with pastors and church leaders who are skeptical about incorporating or applying for 501(c)(3) for their churches, I often hear, “If we incorporate, then we’ll become a State church.” or “If we become a 501(c)(3) church, then the IRS could come knock on our church door any time they wanted.”

This leads us to the question and topic of today’s blog, “Can the IRS really demand your church’s records?”

A federal district court in South Carolina recently halted a religious corporation’s attempt to block an IRS request of the organization’s bank records.

In 2015 the IRS informed the organization that it had been selected for an audit and that access to the organization’s bank records would be needed.

In response, the organization’s accountant informed the IRS agent leading the audit that the organization was claiming church status and all protections afforded under section 7611 of the tax code.

The IRS responded by sending the organization a “notice of church tax inquiry” specifically listing the areas that were to be addressed.

So what does this mean to you and your church?

I want to use the remainder of this blog to give you best practices that will help protect your church from an IRS audit.

But first, we need to address how an IRS church audit can begin.

How an IRS church audit can begin

The truth of the matter is that the IRS cannot just simply knock on the doors of your church and demand to see records and board meeting minutes on the spot.

There is a stringent process that the IRS must abide by according to section 7611.

Consider the following:

Internal Revenue Manual 4.76.7.4 defines a church tax inquiry “as any inquiry to a church…that serves as a basis for determining whether the organization qualifies for tax exemption as a church, or whether it is carrying on an unrelated trade or business or otherwise engaged in activities subjected to any IRC tax.”

Furthermore, section 7611 of the Internal Revenue Code gives guidelines as to how the IRS may begin a church tax inquiry. According to section 7611, the IRS may begin a church tax inquiry only if:

1. an appropriate high-level treasury official reasonably believes (on the basis of facts and circumstances recorded in writing) that the church is not exempt, by reason of its status as a church, from tax under section 501(a), or that it may be carrying on an unrelated trade or business or otherwise engaged in activities subject to taxation; and
2. the IRS sends the church a written inquiry notice containing an explanation of 1) the concerns which gave rise to such inquiry, 2) the general subject matter to such inquiry, and 3) the applicable administrative and constitutional provisions with respect to such inquiry and the provisions of the title which authorize such inquiry.

In essence, we see that in the event of a church audit, the primary goal of the IRS is two-fold:

• to determine whether the church is operating in a manner consistent with its purpose and section 501(c)(3), and
• to determine whether the church is conducting any unrelated business activities.

Before we look at how you can prevent an IRS audit of your church, we need to first understand what may help the IRS establish “reasonable belief” in order to begin the process of a church audit.

5 ways to help your church prevent an IRS audit

1. Maintain board meeting minutes

It is often assumed that the most important records for a church to maintain are its financial records.

Although it is important for churches to maintain good financial records, especially for stewardship purposes, it can be argued that board meeting minutes are the most important records for churches to properly maintain. 

Board meeting minutes serve as the official documentation of the corporate acts of your church.

Without board meeting minutes, your church cannot show proof that the church properly approved corporate actions such as the appointment of board members, the adoption of your bylaws and policies, and the approval of salaries. 

As a nonprofit organization, it is imperative that all corporate actions of the church be properly documented in well-maintained board meeting minutes.

(Recommended reading: "Do You Know How to Take Board Meeting Minutes?")

2. Document all salaries and compensation

Salaries, and compensation in general, should be maintained with diligence.

It is necessary for all salaries to be approved annually, by the board of directors, during a properly called board meeting.

Additionally, salary compensation agreements should include, but are not limited to, the monetary amount to be paid, what the job entails, the number of hours required, and comparability data for other similar positions.

3. Review your church’s activities

As we saw earlier in this post, one of the purposes of the IRS during a church audit is to determine whether the church is operating in a manner that is consistent with its purpose and section 501(c)(3).

Therefore, it is important to review the activities of the church in order to make that determination.

When reviewing the activities of your church, you will want to make sure that each ministry and department directly relates to the purpose of your church. 

If, through your review of church activities, you determine that an activity may be considered an unrelated trade or business activity, such as a bookstore or coffee shop, then you will want to consider starting a for-profit arm of the church.

(Recommended reading: "Can Our Church Own a Business?")

4. Review your church’s printed and publicized materials

Since the IRS can use any printed or publicized material as a source of “reasonable belief” to begin a church inquiry, you will want to be sure to keep a close guard on such materials.

This also includes your church’s website.

It is best not to include any type of advertisements on your church’s website, which, depending on the facts and circumstances, may be considered an unrelated business activity and could potentially jeopardize your church’s tax-exempt status.

5. Review all of your church’s internal governing documents

There are several documents that your church must review and maintain on a regular basis, such as:

1. The church’s articles of incorporation, amendments, annual reports, charity registration, IRS approval letter, and any letters regarding the church updating its public record.
2. The church’s bylaws.
3. The church’s written doctrines.
4. The church’s policies and procedures. (You will want to make sure that your church has a conflict of interest policy, accountable reimbursement policy, and a benevolence policy.)
5. Corporate contracts such as leases and titles to property.
6. Accounting and financial records.
7. Current and accurate membership records.

How would your church hold up in an audit?

Perhaps you are looking at these five steps and realize that your church might not do so well in the instance of an IRS audit.

I want to encourage you not to worry.

The best way to move forward is to correct what was done in the past and make sure proper practices and procedures are set in place for the future. If you have questions and are in need of assistance, give us a call at 877-494-4655.

At StartCHURCH, it is our goal to help you protect what God has given you to lead. We do this in a number of ways, and one of those ways is through our Ultimate Church Structure Conferences.

Click on the link provided below and register for a conference in a city near you.

Recommended blogs for you:

• "IRS Rules Church Coffee Shop Not Tax-Exempt"
• "How to Start a Church the Right Way"
• "6 Mistakes Made When Paying Pastors"

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