Religious congregations usually enjoy greater protection from federal government oversight than other not-for-profit organizations. For example, the IRS can’t conduct a “church tax inquiry” unless a high-level Treasury Department official has written evidence that a religious organization has violated tax-exempt rules.
However, you’d do your faith group a great disservice it you failed to observe IRS rules and financial best practices. Even if your congregation escapes government scrutiny, it could fall victim to fraud — or general mismanagement — that harms your members and reputation.
To effectively prevent financial and other critical mistakes, make sure your religious congregation complies with IRS rules and federal and state laws. In particular, watch out for unrelated business income tax (UBIT). If your organization regularly engages in any type of business activity that’s unrelated to its religious mission, be aware of certain tax and reporting rules. Income from such activities could be subject to UBIT.
For example, if you charge members of your congregation to park in your lot to attend religious services, that income generally isn’t taxable. However, if you collect parking fees from the general public to use your lot, they are likely to be subject to UBIT. Other sources of unrelated business income can be publications, clothing and other merchandise, advertising, and gaming activities that generate income. If your organization has $1,000 or more in annual income from unrelated business income, it must file Form 990-T with the IRS.
Other issues to watch for
Religious congregations aren’t always clear about employment status and wages for clergy and other workers. Most clergy should be treated as employees and receive W-2 forms. Typically, they’re exempt from Social Security taxes, Medicare taxes and federal withholding but are subject to self-employment tax on wages. A parsonage (or housing) allowance can reduce income tax, but not self-employment tax.
If you have employees, you must withhold federal, Social Security and Medicare taxes from their paychecks. You also must follow federal labor laws, such as those related to minimum and overtime wages.
In this election year, it’s important to understand that your organization shouldn’t devote a substantial part of its activities to attempting to influence legislation. Religious organizations are generally barred from endorsing or campaigning on behalf of political candidates or parties. Otherwise, you might risk your tax-exempt status and face potential penalties.
Faith groups can be particularly vulnerable to fraud because they generally foster an environment of trust. Also, they may be reluctant to punish offenders. Just keep in mind that even the most long-standing members may be capable of embezzlement when faced with extreme circumstances.
Require that at least two people handle all contributions. They should count cash in a secure area and verify the contents of offering envelopes. Next, they should document their collection activity in a signed report. For greater security, encourage your members to make electronic payments on your website or sign up for automatic bank account deductions.
Even though religious congregations aren’t required to file tax returns or conduct financial audits, they must comply with applicable IRS rules and other regulations. Contact our nonprofit specialists with questions.