The Refundable Tithe Dilemma
By Raul Rivera
Refunding a tithe or any other type of contribution to a church may have tax consequences for the giver. Moreover, the church needs to take certain due diligence measures to ensure that the person being refunded understands that the refund may impact his tax return. While I teach churches to reserve the refunding of donations to very rare and extenuating circumstances, it is important that any refund you give be accompanied by an explanation that the refund may negatively impact his tax return. Failure to do so may give the appearance that the church is aiding and abetting the donor to evade a tax. My personal conversations with thousands of pastors at our Ultimate Church Structure conferences tell me that aiding and abetting happens often. Today, I want to share with you two ways in which churches aid and abet an individual to underreport his income, causing severe penalties on the individual, church, and even board members.
Aiding and abetting mistake #1: refund of a donation
Giving $25,000.00 to his church was a big deal. Hector and his wife prayed about giving to the church's building fund and made the large contribution because they believed in the pastor and the vision of the church. They made the donation in October of 2010 and got a tax-deductible receipt in January of 2011 in order to claim the donation as a charitable contribution and get a deduction. Then in June of 2012 the church leadership decided that it was no longer in the church's best interest to continue a building fund and decided to refund all of the money they had collected. Though Hector was saddened that the church terminated the building campaign, he and his wife accepted the refund and began to pray about how to use it. Five months later they donated it to an orphanage in West Africa. The orphanage gave him a charitable contribution statement and he got another deduction for it for tax year 2012.
How the law was broken
What the church and Hector did not know was that there are tax consequences when dealing with refunded tithes and offerings. In Hector's case, he made a donation in one tax year and got a refund in another year. Hector and his church were unaware that several sections of the IRS code were being violated.
1. Section 111: When a church refunds an individual for a donation that was made in a previous year, it may fall under recovery of tax benefit items. In Section 111, if a person makes a donation and he gets a tax deduction for it, but later gets a refund of the donation, he is required to report the refund as taxable income in the year he gets a refund. Hector was required to report the $25,000.00 refund on his tax return and pay federal income tax on it. He thought about it, but felt it was better for him to not ask.
2. Section 6701: This section imposes an aiding and abetting penalty on any person or corporation that engages in an action that would result in an understatement of the liability for tax of another person. Subsection (d) places a big burden on the church to inform the taxpayer of the recovery tax benefit and his responsibility to report it. Hector's church was not aware that they were aiding and abetting Hector to underreport his income.
Aiding and abetting mistake #2: excessive housing allowance
Section 107 allows a church to provide a minister with a home as part of his compensation or actually compensate him with cash that has been designated as a housing allowance. When done correctly, the minister can enjoy this compensation without having to report it on his income tax return. However, there are times when the church aids and abets a minister to underreport his income by improperly setting up the housing allowance. This can happen in two different manners, as described below.
1. Excessive housing allowance: The IRS' Minister Audit Technique Guide trains an agent to look at the value of the housing allowance and compare it with the actual value of the services provided to the church. Let me give you an example. Church ABC has a part time minister. He works about 5 hours per week for the church. The church pays him a salary of $10,000.00, plus they provide him a parsonage. The annual rental value of the parsonage is $20,000.00. The minister's total compensation is $30,000.00. When reporting his taxes, the minister does not report the $20,000.00 on his tax return because it is housing allowance. However, when auditing his tax return the IRS agent will investigate to determine if the five hours per week that the minister provides the church is worth $30,000.00. There are several penalties that a church can incur when this happens. The church can incur an aiding and abetting penalty under section 6701 while board members may be fined up to $20,000.00 each for approving an unreasonable compensation agreement.
2. Retroactive housing allowance: Churches often fail to designate a housing allowance at the beginning of the year. The rules governing the housing allowance strictly state that a housing allowance must be designated in advance of the compensation. Therefore, when a church designates a housing allowance in the middle of a year, it can only do it for the remaining months of that year. The problem is that many churches have taken the liberty to retroactively report a housing allowance by backdating the board meeting in which it was approved. While it may seem like a small matter, 18 USC Section 1519 has a lot to say about it. It reads as follows: "Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both." In addition, it is a clear violation of section 6701 because it aids and abets the minister to underreport his income.
Closing
This topic may be difficult, but necessary. God has called you to build His house. When you pastor His flock you are building His house. That can only be done through spiritual wisdom. Moreover, Proverbs tells us that it is through knowledge that its rooms are filled with rare and beautiful treasures (Prov. 24:3). In the same way, knowledge is what gives you the power to lead the legal, business side of your church.