Zondervan 2003 Church and NonProfit Tax and Financial Guide

Zondervan 2003 Church and NonProfit Tax and Financial Guide

by Daniel D. Busby


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Product Details

ISBN-13: 9780310243298
Publisher: Zondervan
Publication date: 12/01/1902
Pages: 216
Product dimensions: 7.38(w) x 9.18(h) x 0.65(d)

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Zondervan 2003 Church and Nonprofit Tax & Financial Guide

For 2002 Returns
By Dan Busby


Copyright © 2003 Zondervan
All right reserved.

ISBN: 0-310-24329-7

Chapter One

Recent Developments

Challenge to the minister's housing allowance is dismissed

Rev. Richard Warren, pastor of Saddleback Valley Community Church in California, sued the IRS in 1998 in connection with its position that he had excluded an excessive amount from his income in the form of a ministerial housing allowance designated by his church. Two primary issues were raised:

Is the amount a minister may exclude from his or her taxable income as a housing allowance limited to the lower of the fair rental value of his or her home or the cost of providing a home?

May all of a minister's compensation properly be designated by a church as a ministerial housing allowance?

Prior to the Warren case, the IRS's official position was that the amount that may be excluded from income was the smallest of the following:

The amount used to provide a home (that is, the total of all housing expenses, including mortgage payments or rent, taxes, insurance, furnishings, repairs, utilities, and improvements).

The amount officially designated by the church.

The fair rental value of the home including utilities and furnishings.

Rev. Warren's housing costs exceeded the annual fair market value rental of his home. For 1993-95, he reported as taxable compensation from the church the amount paid to him by his congregation, reduced by the amount of actual housing costs he incurred. For example, in 1994 he received $86,175 as compensation from his church. He paid $76,309 in housing expenses on his $360,000 home in Trabuco Canyon, California. Therefore, he reported $9,866 as taxable income for the year. For all but one of the years in question, the church designated the full amount of his compensation as a housing allowance.

The fair rental value of the Warrens' home for the years in question was less than the amounts designated as a housing allowance and less than what Rev. Warren spent in each year in providing a home. Accordingly, the IRS, in auditing the pastor, assessed him for taxes on the amounts by which his housing allowance exceeded the fair rental value of his home for the years in question.

The Tax Court agreed with Rev. Warren's position in 2000 that the law does not limit the exclusion for a ministerial housing allowance to the fair rental value of the minister's home. The court held that amounts designated by a church as a housing allowance for a minister may be excluded from income to the extent that the allowance is used to provide a home.

The IRS argued that it was implicit in federal law that not all of a minister's compensation may be designated as a housing allowance. The Tax Court disagreed with the IRS noting that the law did not indicate any limit on the portion of a minister's pay that may be excluded as a housing allowance. The court acknowledged that a minister with additional income from another source (Rev. Warren had income from books and tapes during the three years in question with an annual average profit of $207,602) could spend more for housing and gain a larger exclusion than a minister without additional income or assets, but this possibility has no bearing on how the statute should be interpreted.

The IRS appealed the ruling in 2001 to the Ninth Circuit Court of Appeals. In March 2002, the Ninth Circuit Court of Appeals issued an order appointing Professor Erwin Chemerinsky of the University of Southern California Law School to serve as amicus curiae and both parties to submit supplemental briefs on three issues: (1) Does the court have the authority to consider the constitutionality of Section 107(2); (2) If the court has the authority, should it exercise it; and (3) Is Section 107(2) constitutional under the establishment clause? The briefs were subsequently filed.

Attempting to short-circuit the fair rental value issue in the Warren case before the Ninth Circuit, Congress passed the Clergy Housing Allowance Clarification Act of 2002 (see pages 3-4). Proponents of the law believed it would nullify the possibility of the housing allowance being ruled unconstitutional by the Ninth Circuit Court of Appeals. Later the same day that Bush signed the Act, May 22, the Department of Justice and Pastor Rick Warren filed a stipulation of dismissal of the lawsuit. They said the IRS was precluded under the new legislation from continuing the case. However, Chemerinsky filed a motion to intervene as a private taxpayer on May 29, 2002, and opposed the dismissal.

On August 26, 2002, the Ninth Circuit Court of Appeals dismissed Chemerinsky's motion challenging the constitutionality of the minister's housing allowance. This dismissal effectively ends the current challenge to the housing allowance. Another lawsuit would be required to address the constitutionality issue.

In 1983, the IRS ruled that a minister cannot deduct mortgage interest and real property taxes if the amounts are excluded from cash housing allowance. However, Congress reversed the IRS in 1986 and placed into law a protection of the combination of the deduction and the exclusion. While the Warren case did not address the double benefit of mortgage interest and taxes, several law professors have recently called for a reversal of what they term "discrimination" against nonminister taxpayers.

With the constitutionality issue behind us for the moment, ministers who provide their own homes should turn their attention to complying with the Clergy Housing Allowance Clarification Act of 2002.

President signs housing allowance bill

On May 20, 2002, President Bush signed the Clergy Housing Allowance Clarification Act of 2002, Public Law 107-181. The law amended Section 107(2) of the Internal Revenue Code and states that a minister's cash housing allowance may "not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities."

The bill, introduced by Congressman Jim Ramstad (R-MN), cleared the House on April 16 by a vote of 408-0. On April 18, 2002, S. 2200 was introduced by Senators Baucus (D-MT) and Grassley (R-IA). The Senate bill was passed unanimously on May 2, 2002.

The new housing allowance law clarifies the fair rental value limitation but it does not address constitutionality issues. Thus, ministers may lack the freedom to defend their rights in the courts. Challenges to the IRS by ministers may become constitutionality cases. Few ministers have the time and money to mount a constitutional case. This gives the IRS a tremendous advantage on future examination of minister's tax returns, virtually assuring that ministers will be required to let the IRS win.

The new law amended Section 107 of the Internal Revenue Code by inserting the phrase: "and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities."

The new law generally is effective with 2002 tax returns. If your 2001 return was filed before April 17, 2002:

If you limited your housing allowance exclusion by the fair rental value, you are not eligible to file an amended return to increase your exclusion.

If you did not limit your housing allowance exclusion by the fair rental value, you are not required to file an amended return to decrease your exclusion.

If you filed your 2001 return after April 16, 2002, your housing exclusion is limited to the smallest of:

The amount used to provide a home (that is, the total of all housing expenses, including mortgage payments or rent, taxes, insurance, furnishings, repairs, utilities, and improvements).

The amount officially designated by the church.

The fair rental value of the home including utilities and furnishings.

Standard mileage rates

Even though inflation continues to eat away at our purchasing power, the IRS has decided the cost to operate a passenger automobile is lower in 2002 than it was in 2001. Therefore, the IRS has announced a decrease in the business, moving, and medical mileage rates for 2003. The optional standard mileage rates for employees to use in computing the deductible costs in connection with the operation of a passenger automobile for business, charitable, medical, or moving expense purposes are as follows:

                        2002 Rate     2003 Rate
Type of Expense   (per mile)     (per mile)

Business      36.5 cents     36 cents
Charitable      14 cents     14 cents
Moving/Medical      13 cents     12 cents

2003 per diem rates

Nonprofit employers that help their employees cover business travel expenses have two basic options: (1) The employer can pay employees the precise amount of their expenses, or (2) the employer can opt for convenience and pay a set "per diem" allowance for each day of business travel.

Per diem allowances that stay within IRS-approved rates satisfy the tax law's tough accountable plan requirements almost automatically. All the employer has to do is get records of when, where, and why the employee made the trip. The employee does not have to account for actual dollars spent or keep receipts.

Employers can opt for a two-tier set of "high-low" reimbursement rates, or they can tie tax-free travel allowances to the amount the federal government provides to its employees for travel to a particular location. An employer must pick one method or the other for each employee.

Per diem allowances apply to employer reimbursements. These rates may not be used to claim deductions for unreimbursed expenses. The high-cost areas are identified in IRS Publication 1542.

The federal per diem rate is the sum of the federal lodging rate and meals and incidental expenses rate. The 2003 per diem rates for travel within the continental United States are: [TABLE]

For 2002, an employer can sell transit passes and tokens to ministers and other employees at discounts of up to $100 (up from $65 in 2001) per month tax-free. Or, an employer can just give cash of up to $100 for passes and tokens tax-free. Also, if an employer gives an employee a parking space near its premises, it is tax-free to the employee up to a value of $185 per month. It is also tax-free up to $185 per month if the employee rents a space near the employer's premises and is reimbursed. The cost of a parking space located at the employer's residence is taxable to the employee regardless of its proximity to the employer's premises.

2002 token limitations

Donations are fully deductible when benefits to a donor are small and part of a fund-raiser and the benefits qualify under the token limitation rules. Examples of these benefits might include mugs, key chains, posters, shirts, tote bags, and so on. Free, unordered low-cost articles are also considered to be insubstantial.

The value of the benefit to the donor cannot exceed the lesser of 2% of the gift or $79.00 (2002 inflation-adjusted amount). The donor can get a token item (T-shirt, for example) bearing the name or logo of the charity and costing $7.90 or less for contributions that exceed $39.50.

2002 social security taxable earnings limit

The maximum amount of taxable and creditable annual earnings subject to the social security and self-employment income tax increased to $84,900 in 2002, up from $80,400 in 2001. There is no maximum wage base for Medicare.

2002 highly compensated employee definition

The "highly compensated employee" definition is important in determining whether certain fringe benefits are taxable to employees that fall within that category. Examples of fringe benefits that may trigger additional compensation based on favoring highly compensated employees include: qualified tuition and fee discounts, educational assistance benefits, dependent care plans, group-term life benefits, and self-insured medical plans.

Employees who have compensation for the previous year in excess of $90,000 (2002 limit) and, if an employer elects, were in the top 20% of employees by compensation meet the definition. Failure to comply with the nondiscrimination rules does not disqualify a fringe benefit plan entirely. The benefit simply is fully taxable for the highly compensated employees.

Pension reform changes

The Economic Growth and Tax Relief Reconciliation Act of 2001 contained a number of important retirement-related provisions. Many of the changes became effective for plan years beginning in 2002. The changes expire on December 31, 2010, unless Congress affirmatively acts to extend them.

* Defined contribution plan limits. Annual contributions to a defined contribution plan, per participant, are limited to the lesser of 100% of compensation or $40,000 for 2002. This $40,000 dollar limit is subject to more rapid indexing with annual cost of living adjustments in $1,000 increments, instead of the $5,000 increments under the pre-2002 rules.

* Repeal of maximum exclusion allowance. The maximum exclusion allowance of section 403(b)(2) is repealed effective with 2002. Related to this repeal, section 415(c)(4) catch-up contributions are eliminated that were available to churches and certain other nonprofit organizations. However, the special $10,000 per year/$40,000 lifetime contributions limit for church workers is still in effect.

* Elective deferral limit. For 2002, the maximum annual amount of elective deferral that an individual may make to a section 401(k) plan or a section 403(b) annuity (tax-sheltered annuity) is $11,000. The contribution limits have been increased for all types of retirement arrangements permitting participants to contribute larger amounts to retirement plans. The annual limit is increased from $11,000 to $12,000 for 2003. The limit is further increased $1,000 per year until reaching $15,000 in 2006 (and is indexed after 2006 in $500 increments), as reflected in the following table


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