We Are a Church, But IRS Says We Are a Ministry
By Raul Rivera
Pastor John established Lakeside Church1 in his home. In three months, the church became a sanctuary for 18 regular attendees who gathered every Sunday morning for worship and every Wednesday evening for prayer. Inspired by the growing congregation, Reverend John sought to solidify the church's future by applying for 501(c)(3) tax-exempt status, hoping to cement their mission and enable them to guarantee the members who gave tithes and offerings a deduction on their taxes.
A few months after submitting the 501(c)(3), the IRS responded to Reverend John’s application. They were willing to approve the application, but with an unexpected twist—they would NOT recognize Lakeside Church as a church but rather as a ministry, or in their terms, a "religious nonprofit." This classification caught Reverend John off guard, sparking immediate concern about the implications.
“Is there a difference between a church and a ministry once they are both under 501(c)(3) status?” Reverend John wondered. He grappled with the IRS’s offer, questioning whether to accept this classification or insist on being recognized explicitly as a church. Would accepting the status as a ministry affect their operations or how they were perceived by their congregation and potential donors?
Faced with this decision, Reverend John realized the importance of understanding the distinctions and implications of each classification.
Legal Distinctions and Tax Code Treatment
Pastor John is correct in questioning if there is a difference. While both churches and ministries are eligible for tax-exempt status under Section 501(c)(3), The tax code classifies them differently, which subjects them to different regulations.
Churches are categorized under 509(a)(1) and 170(b)(1)(A)(i).
Ministries are categorized under 509(a)(1) and 170(b)(1)(A)(vi).
This classification is crucial as it affects how these organizations are treated once they achieve their 501(c)(3) status.
IRS Classification and the 14-Point Test
The Internal Revenue Service (IRS) utilizes a 14-point test in Schedule A of the 1023 application to classify an organization as a church. The term church is found in the Internal Revenue Code but is not specifically defined.
Certain characteristics are generally attributed to churches. These church attributes have been developed by the IRS and court decisions.
They include:
- Distinct legal existence
- Recognized creed and form of worship
- Definite and distinct ecclesiastical government
- Formal code of doctrine and discipline
- Distinct religious history
- Membership not associated with any other church or denomination
- Organization of ordained ministers
- Ordained ministers selected after completing prescribed courses of study
- Literature of its own
- Established places of worship
- Regular congregations
- Regular religious services
- Sunday schools for the religious instruction of the young
- Schools for the preparation of its ministers
The IRS generally uses a combination of these characteristics and other facts and circumstances to determine whether an organization is considered a church for federal tax purposes. Sometimes, an organization might apply for recognition as a church but fail to meet enough criteria from the 14-point checklist, leading the IRS to attempt to classify it as a ministry instead.
Differences in Responsibilities and Privileges
The differences in classification carry significant implications for how these entities operate and comply with federal regulations:
If Classified as a Ministry:
- Annual Tax Returns: Ministries must file Form 990 each year, detailing their financial activities and operations. Failure to file for three consecutive years can result in the loss of tax-exempt status.
- Charitable Solicitations Registration: In over 40 states, ministries must register before soliciting donations, which includes a wide range of fundraising activities.
- IRS Audits: Ministries are subject to standard IRS audits, similar to other public charities.
If Classified as a Church:
- Annual Tax Returns NOT Required: Churches are not required to file the annual Form 990 tax return.
- Charitable Solicitations Registrations NOT required: Churches do not need to register for fundraising activities.
- Restricted IRS Audits: The IRS can only audit a church under specific circumstances, such as suspicions of ineligibility for tax exemption or undeclared taxable activities, and only with approval from a high-level Treasury official.
- Option to Elect Out of FICA: Churches with specific religious objections to Social Security and Medicare can opt out of the employer’s share of FICA taxes by filing Form 8274 in a timely manner.
What should Pastor John Do?
Pastor John was at a crossroads, needing to decide whether to accept the IRS's offer to classify Lakeside Church as a religious nonprofit or to insist on a church designation. Understanding the differences and responsibilities associated with each option, he contemplated the following strategies:
- Accept Ministry Classification Now with Potential for Future Reclassification: Pastor John could accept the initial classification as a ministry to secure the 501(c)(3) status, which does not preclude Lakeside Church from being recognized publicly as a church. In the interim, Lakeside Church would need to fulfill the requirements applicable to ministries, such as filing an annual 990 tax return and registering for charitable solicitations in the state. This route offers the advantage of immediate tax-exempt status while leaving the door open for reclassification as a church once more of the IRS's 14 criteria are met in the future.
- Advocate for Immediate Church Classification: Pastor John's second option is to continue dialoguing with the IRS, emphasizing that Lakeside Church, despite currently having only 18 members and meeting in his home, has written plans to grow and move into a separate facility. By demonstrating how Lakeside Church is moving to meet most, if not all, of the IRS's 14-point criteria, he could persuade the IRS to classify it as a church from the beginning. This approach might take longer to get 501(c)(3) approval as a church, but it would exempt Lakeside Church from the need to file a 990 tax return and from registering as a charity, aligning better with its long-term vision.
There isn't a clear-cut right or wrong decision for Pastor John. Each option would put Lakeside Church on the path toward securing its 501(c)(3) status as a church. The best choice largely depends on how many of the IRS's 14-point test items Lakeside Church currently meets and how much complexity Pastor John is willing to navigate with the IRS.
At StartCHURCH, we are familiar with handling scenarios like Lakeside Church on a regular basis. We guide churches through every step of the process, advising them on whether to push for immediate church classification or accept a ministry classification to secure a reclassification as a church when the right time comes.
Conclusion
Navigating the complexities of IRS classifications and ensuring compliance can be a daunting task for any church or ministry. Understanding the nuances between being classified as a church or a ministry and the responsibilities each entails is crucial for making informed decisions that align with your organization's goals. If you're facing challenges similar to those faced by Pastor John, you don't have to go through this process alone. Call us at 770-638-3444 to learn how our StartRIGHT service can guide you through each step, from incorporation and obtaining a Federal EIN to establishing Bylaws, Policies, securing 501(c)(3) status, ordination, and much more. Let StartCHURCH help you lay a strong foundation for your church or ministry's future.