One of the biggest pains in the neck for church administrators is managing expenses incurred by employees (primarily ministers) on behalf of their church. Many ministers are very good about asking for the reimbursement but very deficient in sticking to accountability requirements. In spite of knowing that expenses reimbursed without accountability MUST be reported as income, to avoid paperwork some ministers will simply tell the administrator to “Put it on my W-2 and I will deduct the expenses myself.” For several reasons this makes no economic sense.
If a married minister has itemized deductions less than the Standard Deduction amount of $11,900 he will get no deduction to offset the additional income.
But, even if a minister does itemize, he will get to deduct an amount nowhere near the total of his business expenses because:
- Miscellaneous Itemized Deductions (which include business expenses) must be reduced by 2% of his income.
- Any of his payments for meals and entertainment must be reduced by 50%
- The Deason Rule must be applied which reduces business expenses by the ratio of the housing allowance received to total compensation.
The best economic course for the minister is to give in and submit to an “accountable reimbursement plan”. If only he will, all business expense reimbursed will be totally excluded from taxable income. In other words his “deduction” will be 100%!
In order to take advantage of this an accountable reimbursement plan must at a minimum:
- Be in writing
- Require adequate documentation of the business purpose of the expenditure
- Require substantiation within 60 days of the expenditure
- Require excess advances to be returned within 120 days
- Not allow advances to be made more than 30 days in advance of the event
Overlooked danger zone – Automatic excess benefits
If reimbursements are made to a senior minister, officer or director of the church and NOT included in the individual’s W-2 income, Intermediate Sanctions (Mentioned in the previous post) may be assessed. The IRS deems these transactions as “Automatic Excess Benefits”.
Many churches pay little attention to the concept of “reasonable compensation”.
Nonprofit organizations, of which churches make up by far the largest percentage, must serve public interests not private. As a result, an individual should not receive assets from a nonprofit entity simply because they have a significant relationship with the charity. If this happens, the private inurement might have occurred. If the IRS finds that inurement has occurred, painful penalties, called “intermediate sanctions” may be assessed on the individual receiving the resources. Penalties may also be assessed on the organization’s board for allowing this to happen.
One often overlooked aspect of private inurement is the concept of compensation. Nonprofit organizations can only pay a reasonable compensation to its employees. Like beauty, reasonable can be in the eye of the beholder. So, what is reasonable compensation?
Fortunately, the IRS lays down some guidelines to help answer this question. If a church:
Requires an independent compensation committee to set salaries that,
Based its decisions on comparative data of other similar churches and,
Documents its decisions in writing,
a presumption of reasonableness is established.
Overlooked danger zone – The Pastor’s Discretionary Fund
Many churches, for privacy purposes, establish special funds in which the pastor has total control over to cover sensitive benevolence issues. While it is understandable why some churches take this course there is one point that must be made. If any of the funds can be, at the pastor’s sole discretion, be diverted to the pastor or his family, the entire amount could be considered income. If your church has such a fund it would be a good idea to review the terms the church has established (if any) to administer the account.
Many churches think that their state sales tax exemption applies to ALL TRANSACTIONS.
Unfortunately, this is not the case. An exemption from sales taxes only allows the church to avoid taxes on goods and services that it purchases in carrying out its mission. It does not apply to things that it might sell!
There is not necessarily a need to panic if you haven’t been collecting and remitting sales taxes. First, you simply need to educate yourself about how the sales tax process works and see if any of the many exemptions from the tax apply.
For example, in Texas, where I live, the list is long of possible exemptions:
Meal and food products sold at church functions. (Whew! Wednesday night suppers are safe!)
Auctions, rummage sales and other fundraisers
One day sales
Publication fees if published and distributed by the church
These are just a few, and only apply in Texas. Although many of the states operate in a similar fashion, there are differences from state to state. If you are selling stuff, and haven’t thought about taxes, it may be time to give your tax professional a call.
Many churches ignore or do not understand what unrelated business income is.
Very often one of our church clients will call us concerned that they have received unrelated business income. The vast majority of the calls are concerned with the sale of an asset or the rental of their facilities. After giving me the details of what they have done they usually ask, “Are we going to lose our tax exemption?”
In most cases the answer to this question is no because the purpose of the unrelated business income tax is not to punish exempt organizations who engage in unrelated activities. The main purpose is to simply collect taxes! Unless an unrelated activity becomes so large that it is the dominant activity a charity is engaged in, tax exempt status is safe.
The best way to understand the rules is to look closely at the words unrelated and business. Unrelated means activities not directly connected with a church’s defined mission or purpose. So, in the case of casual sales of property, the church has definitely received some “unrelated” income. But, we need to look at the second word, “business”. This word implies that an activity is regularly carried on. In other words, the church is holding itself out as operating a business on an ongoing basis. Very few churches generate this type of income. A few examples are restaurants that are open to the public and parking lot and garage fees.
Rents, by definition are NOT considered unrelated business income, unless the church happens to be renting a facility that was purchased with a mortgage. Even then, there are a myriad of loopholes that may allow the church to escape taxation.
But, even if a church does generate unrelated business income, there is nothing to worry about unless the activity dwarfs the church’s main exempt purpose. The tax code is simply trying to level the competitive playing field. If a church is entering the market place, it should have to pay taxes just like its competitors.
Part 12 of our ongoing Fraud in the Church series. PSK in cooperation with the National Association of Church Business Administration (NACBA) conducted a survey to determine the extent to which churches are attempting to address the problem of church fraud. We asked them to respond to this statement:
Our church has implemented a written credit card policy to control credit card purchases.
Ok, I know I was a little harsh in the last post… I guess it’s because I have seen too many credit card train wrecks! The million dollar event I discussed in the last post was definitely the largest, but I have seen many of its smaller brothers and sisters.
Although over 80% of the surveyed churches issue church-named credit cards, the results of the next query gives me some comfort. 70% of these churches have implemented a church credit card policy to monitor credit purchases. Unfortunately, that leaves nearly a third with no documented policies to give oversight over credit card purchases. Based on the things I have seen, these 30 percenters are living on the edge.
It is imperative that any church issuing credit cards to employees and volunteers has a credit card policy to lay down usage guidelines.
At a bare minimum a church credit card policy should:
- Limit the dollar amounts of single purchases, and
- Restrict the use of the cards to certain businesses.
What would you add to these two requirements?
Part 11 of our ongoing Fraud in the Church series. PSK in cooperation with the National Association of Church Business Administration (NACBA) conducted a survey to determine the extent to which churches are attempting to address the problem of church fraud. We asked them to respond to this statement:
Our church issues credit cards (in the church’s name) to employees and/or volunteers.
At a response rate that came as no surprise to me, 86% of the churches who took part in our survey issue credit cards to employees. It continues to amaze me how many churches follow this practice. Seldom do we see this in our work with commercial clients. Most businesses with accountable business expense reimbursement plans require employees to use their own cards. This is particularly true with smaller organizations. Some larger companies do issue corporate cards, but all of them I have seen keep the employee on the hook by including the employee on the account: The employee pays the bill AFTER being reimbursed by the company. Employees of businesses that follow this procedure tend to be more responsible credit card users because there is always the possibility that their employer may say, “NO!”
Why do we consider the issuance of credit cards (in the church’s name) a fraud risk? I have a simple answer:
The largest church credit card fraud investigation I have conducted resulted in more than one million dollars in losses.
Illicit use of just two credit cards was responsible for 75% of the theft!
Without sufficient oversight, credit cards can turn the entire purchase approval system on its head. I have seen it happen…
Many churches fail to implement a well defined purchase approval and payment system
There is a great difference in attitude in the church environment between receipts and disbursements. While churches exercise extreme vigilance over the “inflow” of funds into the church, many have a rather cavalier attitude towards the “outflow”.
Churches also tend to rely on a few “fraud prevention” methods which in my opinion provide little more protection than a security blanket. They may give a warm and fuzzy feeling, but are no help in a real crisis. The two I hear most often are the requirement of dual signatures for checks over a predetermined amount and the requirement that a check request form be filled out before anyone gets paid. It is not uncommon for these to be the only two “fraud prevention” controls exercised over cash disbursements.
KEY: Churches that rely on methods this simple are unaware of two basic facts. First, dual signatures and homemade check requests are absolutely no match for an ethically challenged employee with the courage to forge. Second, and this may be the most surprising, many of the larger and more spectacular embezzlements involve tampering with the church’s cash outflow, not the inflow.
An important element of proper stewardship is to develop, implement and live by a well defined, written bill approval and payment process. Some key ingredients of such a plan:
A clear description of who will:
Validate invoice with purchase order and receiving documents
Prepare checks for payment
Record transactions in the general ledger
Use of pre-printed, sequentially numbered purchase orders, not check request forms that anyone can duplicate on a copy machine.
A vendor application and approval process culminating in an approved vendor list
Write checks and/or make drafts only to vendors on the list
Consider using a Positive Pay program in partnership with your bank.
Part 10 of our ongoing Fraud in the Church series. PSK in cooperation with the National Association of Church Business Administration (NACBA) conducted a survey to determine the extent to which churches are attempting to address the problem of church fraud. We asked them to respond to this statement:
Our church has established a “Positive Pay” arrangement with our bank.
Increasingly, due to technological change and advancement, the threat of fraud is no longer limited to dishonest employees. Hackers and other “online bandits” have become quite proficient in draining the bank accounts of the unsuspecting. One defense against this is to establish a Positive Pay arrangement with your bank.
Only 5% of our respondents have this type of bank account protection in place, which is surprising because Positive Pay is a simple three-step process.
- During the check writing process, a list is compiled of bills to be paid.
- The list is sent to the bank.
- The only checks or drafts to be cleared by the bank are those on the list.
I am very curious why so few take advantage of this. Any ideas?
Because of staff size many churches have poor segregation of tasks
Next to the absence of well-defined, written accounting and management policies, the most common weakness we have noticed in churches is the lack of adequate segregation of duties. In other words, the accounting tasks are not spread out among enough individuals. This is usually due to budget constraints, as churches tend to fund ministries first, then whatever is left is applied to administration. Whenever possible, accounting tasks, particularly those involving cash transactions, should be divided between several individuals to limit the possibility or even the appearance of the misuse of funds. There are two main purposes for developing a strong segregation of tasks:
First, strengthening the accounting control system protects the Church from the misuse of funds and loss of assets.
KEY: Second, proper segregation of duties protects Church staff and volunteers from unwarranted charges of impropriety. In my opinion, this is the most important reason for spreading the work around as many people as possible. We must never forget that in volunteer organizations, the appearance of improprieties can cause as much or more harm than actual occurrences of theft or embezzlement.
All churches should investigate ways to protect itself and its staff by finding methods to segregate as many of the accounting duties as possible. Here are some of the weaknesses we have seen in segregation of duties:
Often a church’s offering count teams are made up of the same individuals who perform the task week in and week out. Action Step: Make an effort to enlist as many people as possible to serve as tellers. Also, include a planned rotation of the counters
Many churches on Sunday mornings, store their offerings overnight in a safe that does not require dual access. Action Step: When money remains on Church premises for over twenty-four hours, use a safe that requires the participation of two individuals to unlock. (A less expensive way to do this is use lockable or tamperproof bank bags and assign separate custodianship of the bags and access to the safe)
By far the most common weakness is the habit many churches fall into of allowing the church financial secretary/bookkeeper to be involved in every aspect of the accounting process, particularly those involving cash. Action Step: The church bank account is the “Grand Central Station” of a church’s business activity. One of the most effective steps that can be taken to provide segregation of duties is to remove the bank reconciliation task from the bookkeeping department and assign the work to another employee or volunteer.
Part 9 of our ongoing Fraud in the Church series. PSK in cooperation with the National Association of Church Business Administration (NACBA) conducted a survey to determine the extent to which churches are attempting to address the problem of church fraud. We asked them to respond to this statement:
Our church has established an “approved vendor list”. All payments for goods or services are made only to vendors on the list.
A surprisingly high percentage of our respondents – 82% had not established an “approved vendor list”. A common misconception in the church environment is that, “If we are going to be hit, it will be directed towards our tithes and offerings.” While this does happen frequently, some of the largest dollar losses occur in the disbursement processes, not the receipts. Also, these types of frauds, because of their difficulty of detection, seem to go on for longer periods of time than thefts of cash receipts. From my observations, it seems that many more churches are hit after their revenues are safely in the church’s bank accounts, not on their way in.
The first line of defense against vendor disbursement fraud is the development of well-defined AND well-written bill approval and payment policies and processes.
In addition to purchase orders and check requests, such a system should include a formal vendor selection and retention process. After successfully screening potential donors, the church should develop a preferred vendor list. As part of the check signing process, payees should be compared to the approved vendor list.