Does Your Church Underreport?
By Raul Rivera
The IRS tax gap report reveals that underreporting of income remained the biggest contributing factor to the tax gap. This is a report the IRS releases every so many years and in essence, it shows the amount of tax that is owed and how much of that tax is actually collected on time. There is close to one-half trillion dollars out there that is owed to the IRS, 90% of it primarily due to underreporting.
Underreporting in churches occurs when churches fail to report the payments made to their pastors, guest ministers, musicians, nursery workers, and contractors. Churches often give their guest speakers a love offering either in cash or with a check, and often do not consider if it has to be reported on Form 1099-Misc. This is a very common mistake churches make. Another mistake often occurs with the support churches send to missionaries doing work overseas. Many churches send money to a U.S. citizen who is a missionary, but they do not correctly fill out the proper forms to document that.
How churches underreport
Let me share 3 ways churches underreport and contribute to the IRS tax gap:
1. Pastoral love offerings: There are many “names” to describe the act of blessing the pastor. Some call it a "pastoral love offering", a "love token", or a "first fruit", while others may refer to it as a "love gift" or a "freewill offering". No matter what you call it, in nearly every case, it has to be reported on Form W-2. Every year, millions of dollars in pastoral love offerings go unreported because many churches do not properly report to the IRS these gifts given, as the law requires. Likewise, many pastors, believing it is a gift, do not report it either.
2. Undocumented housing allowance: Many pastors claim that they do not receive a salary. Instead they get a housing allowance. Unbeknownst to many, Treasury Regulation 1.107-1 requires it to be properly documented. Otherwise it is subject to federal income tax. Additionally, unless the pastor has successfully applied for and received self-employment tax exemption, the housing allowance paid to a minister is subject to a self-employment tax of 15.3%. This is a little fact that can bring devastating consequences to churches and ministers today.
3. Improperly documented pastoral salary: Did you know that section 4958 strictly prohibits a salary agreement between the church and the pastor to have any open-ended items? Section 4958 mandates that his/her salary be approved before he/she starts receiving it and that it must be a fixed salary amount. The mistake happens when the church and pastor agree to and document a salary but never discuss love offerings and other sources of income he/she may receive through the church. The church, then, reports the salary but fails to include other income the pastor may receive from weddings, funerals, love gifts, etc.
In closing
The IRS is fully aware that these common underreporting compliance issues exist in churches. It is just a matter of finding them. More than ever, the tax gap is a reminder that the IRS has an ever-increasing incentive to improve its ability to find these issues at the street level. For the Church, our incentive for getting right and staying right goes far deeper than any potential consequences from the IRS. What matters most is that we as the Church do things in excellence because we are in Kingdom business, and it pleases our heavenly Father when we steward things well.