While most individual taxpayers wait until January to begin putting their tax materials together, churches are advised to start getting their paperwork in order now.
Michael R. Williams, a certified public accountant who works with TAB Media, says many churches — particularly the smaller staffed ones — make assumptions that can run afoul of federal and state laws. Here are some of the areas he advises churches to consider before the end of the year.
The Internal Revenue Service automatically recognizes churches as 501(c)(3) charitable organizations, a nonprofit designation that exempts them from federal income taxes.
Many churches believe that because they don’t have to pay into the federal system, they also need not pay state and local sales taxes.
Not true in Alabama, says Williams.
“Religious organizations, including churches, are not exempt from the payment of sales and use taxes.
Generally, sales taxes must be paid when items are purchased for the church’s use,” he says.
“However, certain church-based or church-affiliated educational facilities may be exempt from sales and use taxes. If so, the entity usually requests and receives an exemption certificate from the Alabama Department of Revenue by filing an application.”
Moreover, churches may also need to collect sales taxes on items they sell that are not directly related to their nonprofit missions — say, a retail store or coffee shop located within a church — and remit them to the taxing entity.
Churches and other tax-exempt organizations must withhold income taxes from employee wages, but the rules are different for clergy.
While a pastor may be considered a church employee, all clergy must pay social security and Medicare taxes as if they are self-employed, unless they have filed a Form 4361 to apply for a special exemption from self-employment taxes allowed for ministers.
A clergyperson’s wages are exempt from income tax withholding, but the pastor may ask the church to withhold both income taxes and estimated self-employment taxes. This is a voluntary agreement that may be terminated at any time by either party.
“The church should report this amount on Form 941 as additional income taxes withheld and not as Social Security or Medicare taxes,” Williams advises.
A church-provided parsonage or officially designated housing allowance for clergy must also be taken into consideration with regard to self-employment taxes.
“Love offerings” given by a congregation to active ministers are considered taxable income as well.
More information is available on the IRS “Members of the Clergy” page.
When you figure out what reporting forms you must file, don’t forget the cleaning lady or lawn service guy you hire as contractors to keep your church looking spiffy.
If you pay them $600 or more during the calendar year, you must file either a Form 1099-NEC (for nonemployee compensation) or Form 1099-MISC.
All businesses and organizations — including churches — are considered reporting entities and must file 1099s to notify the IRS of income that should appear on the recipients’ income tax returns. The IRS enforces the 1099 filing responsibility because unreported income costs the government billions of dollars in lost tax revenue every year, Williams notes, resulting in increased deficits and borrowing and pressure to raise taxes.
Williams says the Form 1099-NEC is the most common type churches are required to file. Nonemployee compensation is defined as payments made to businesses and individuals who are not church employees for services.
Some examples of independent contractors include:
- Repair workers
- Cleaning services
- Lawncare services
- Individuals you rent from
- Revival ministers, supply preachers and guest speakers.
Churches do not need to send 1099 forms to:
- Nonprofit organizations and churches.
- Independent contractors paid electronically with a credit card, payment card, third-party network transaction. The payment settlement entity is responsible for reporting those transactions.
- Corporations (except for attorneys doing business as corporations).
Williams advises churches to keep a Form W-9 “Request for Taxpayer Identification Number and Certification” on file for all independent contractors and guest speakers, even if they believe they won’t need to send them a 1099 form.
That way, if things change over the year and you wind up crossing that $600 annual threshold, you have the names, addresses and taxpayer identification numbers you’ll need for the 1099.
“Don’t forget to file the 1099s with the Alabama Department of Revenue as well,” Williams says.
For more information and forms for Alabama taxes, visit the Withholding Tax section of the Alabama Department of Revenue.
Unrelated business income
Churches earning gross taxable unrelated business income of $1,000 or more annually must file a Form 990-T for that year.
Unrelated business activity is a trade or business regularly carried on and not substantially related to the church’s exempt purpose. Some examples include advertising revenue from church publications and websites, various activities such as raffles, sale of merchandise (unless it was donated) and parking lot rental.
Year-end giving statements
Williams says year-end giving statements often neglect to include a simple statement that will protect donors from having their contributions disallowed by the IRS.
“Adding to the year-end statement ‘No goods or services were provided in exchange for this donation,’ or ‘The church provided only intangible religious benefits to the contributor’ is all that’s needed to meet the IRS reporting requirement,” Williams says.
“This is one of the most important items to include in the donor receipt, but unfortunately it’s one of the most commonly missed.”
Williams also recommends reviewing the IRS Publication 1771 for additional giving statement requirements.
Individual donors wishing to claim tax deductible donations typically must itemize them on their tax returns. However, new for the 2020 tax year, taxpayers may deduct up to $300 of cash donations without having to itemize on their individual income tax filing.