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.
It’s so difficult to say goodbye – firing right
Churches should follow prudent steps in firing employees. This begins by making sure that the termination must be for a legitimate, nondiscriminatory reason. Prior disciplinary measures must be consistent with church personnel processes and policies
The first step should be to schedule a meeting that includes the terminated employee, the employee’s supervisor, the church HR director or supervisor’s manager and the church’s legal counsel. (If considered necessary.)
First and foremost, the church should make it a goal to preserve the employee’s dignity. Keeping the meeting as brief as possible contributes to achievement of this goal. A concise explanation to the employee of the reasons for termination should be given along with a carefully documented history of the issues. That is why the performance reviews mentioned in our previous post are so important. Having a documented case history prevents the employee from asserting they were never informed.
KEY: Do not let the employee drag the process into an argument!
If severance pay is offered to the employee, discuss the terms of the severance with the employee. Church property including passwords, office equipment should be collected from the employee by providing the employee with choices of when he or she may pick up personal belongings.
Also, unused benefits, unpaid expense reimbursements, and written permission in regard to references should be addressed.
KEY: In some cases it may be better to deem the termination a resignation, especially in the absence of animosity. It is another way for preserving the employee’s dignity
Happy together; managing your employees
The best way to avoid mistakes in hiring and in firing is to employ simple, repeatable processes to help insure that the right things are done at the right time. One way to do this is to develop a “New Hire Packet” which should be given to each new employee. Some of the items that should be submitted to each employee are:
KEY: A copy of the official church employee manual
A form W-4 to be completed by the new employee
A form I-9 (Department of Labor requires all I-9s to be filed in a stand-alone file)
In addition to providing new hires with relevant forms, the church should maintain a separate file for each employee. Personnel files should be kept in a secure location and it is a good idea to store active and inactive personnel files in separate locations. Medical information must be kept in a separate file from the regular personnel files in order to be in compliance with the Americans with Disabilities Act. Other confidential information that should be kept separately includes the I-9, grievance and investigation records, and garnishments and loans to employees.
In addition, personnel files should include the original application form submitted by the employee, a signed W-4 and a copy of ministerial credentials for all employees hired to serve as ministers. (Ordination, licensing or commissioning certificate.) This is not mandatory, but rather a “best practice” insuring that church ministers are treated properly for income tax purposes. Paycheck deduction authorizations signed by the employee should also be retained and updated.
KEY: Finally, a record of performance reviews, evaluations and reprimands must be maintained on a current basis.
KEY: Many churches keep up with all of this paper work by using a personnel file checklist which assists in making sure all t’s are crossed and i’s dotted.
Getting off on the right foot – hiring right
One way to avoid unhappy situations is to begin on the right foot. And in personnel matters, that means hiring right. Churches should follow prudent steps in hiring their employees. For starters, a church must know what it is looking for in a new employee. That means that job descriptions should be prepared prior to the interviewing process.
Once that is done, a church can then begin recruiting and evaluating potential employees. Here are a few tips to guide churches in the recruiting process:
- Maintain a record, in writing, of all job openings.
- Keep a file of the various advertisements it has placed to recruit applicants.
- Utilize a standardized applicant screening and interviewing process, making sure that managers are properly trained in the conducting of effective and legal interviews.
- Utilize a standard application form which informs applicants of the terms and conditions of employment. (Particularly the right to consider their religious affiliation.)
- The application should avoid unlawful pre-employment inquiries. (Age, race, sex,. etc)
KEY: The application should be reviewed by the church’s legal counsel prior to being used in the hiring process.
Today we continue our discussion of the importance of long-range planning by looking at two other areas where churches need to be taking soundings, to see if storm clouds are on the horizon.
Ignoring long-range giving opportunities
At the present time, our society is going through the greatest asset transfer in world history. Many of the baby-boomers, who have lived through the most prosperous eras of our nation’s history, are reaching retirement age. With ever increasing amounts of disposable income many are also looking for worthy charities to share their abundance with.
Many pastors are surprised when they read in the newspaper or online that one of their members has given a substantial endowment gift to the local university or hospital. Some pastors screw up the courage to ask why the church was not the beneficiary only to hear the following comment. “You never asked.”
Whether churches like it or not, they live in a competitive arena. Various organizations within the nonprofit sector are vying for a limited amount of donor dollars. Churches also need to realize that secular charities are asking their members for significant gifts. Maybe the churches should too…
When it comes to fund-raising, few churches look past current budget needs or an occasional building campaign. Very few venture into the planned giving arena. Perhaps it is time to begin.
Failure to address demographic change in the church’s mission field
In the last few decades, immigration has drastically changed the demographic makeup of our nation. In the course this major shift, neighborhoods have taken on a new look and culture. Unfortunately, many churches failed to adapt to their surroundings, and as a result, have seen a dramatic decline in membership. In fact, many have ceased to exist.
Because most of these churches are in older parts of most cities and towns many church leaders in the growing areas feel somewhat immune to this situation. I think this is a false sense of security. I am getting old enough now to have seen quite a bit in my career providing services to churches. One thing I have noticed is that churches do indeed have a cycle they follow. Eventually, the new becomes old and almost all churches must re-evaluate their situations. It is essential, to be an effective ministry present, each church must evaluate its calling. One way to do that is to have a firm understanding of its surrounding neighborhoods. By paying timely attention to these matters, churches can adapt their efforts and provide ministry to their new neighbors.
Because of dependence on the Whack-a-Mole management strategy, many churches seldom look past their current situation. Unlike ancient sailors who took periodic “soundings” to determine how close they were to shore, many churches take few, if any steps, to determine if they are headed for rocky waters. Unfortunately, a rising number of them do not realize they are in trouble until they run aground.
It is true that the Bible cautions us to not presume on the future. (James 4:13-15) But, churches are also called to be good stewards. As long as the church is acknowledging God’s will in the matter, part of good stewardship includes making some long-range plans. Failure to do so could result in disaster.
Operating without a master plan in regard to land and facilities
Several years ago at one of PSK’s church business administrator breakfasts, we invited the local fire marshal to speak on fire safety. He mentioned one thing that surprised me and another thing that made me think of the importance of master planning.
The surprise? Other than petroleum or chemical fires, the fires feared most by firemen are church fires. Because churches are filled with combustible items, paper, wood, fabrics etc. a small electrical problem can quickly ignite into a raging inferno. But what he said next made me realize that poor master planning can be deadly as well.
How does this tie into master planning? The factor that endangers firemen the most is not the presence of combustibles. It is the fact that too many churches are a hodge-podge of different structures. Without an integrated building plan which looks to the future, church structures tend to become a series of additions added one to another. The result is a confusing maze of hallways, cubbyholes and dead-ends. (Tragically, in some cases this has been too literal).
This can be avoided if churches take the time to plan for the future.
Operating without a formal, written accounting and management policy manual
In addition to a budget, a formal management document is a must to help insure that the church makes appropriate and effective short-term decisions. Written policies and procedure documents assist churches in the administration of activities by helping to set forth in clear, unmistakable terms the mission of the church and how it will be carried out. The manual will also establish and reinforce the organizational structure of the church by providing a clear delegation of duties and responsibilities. It also will serve as a guide to direct and oversee the carrying out of Church activities.
One of the purposes of written policies is to head off problems before they arise. And, in cases when problems do arise, having policies in place makes navigating the choppy waters manageable. For instance, suppose your church is offered a gift of land of a sizeable dollar value. (According to the donor…) The church accepts the land, transfers the title, and later learns the land has significant environmental issues. (For example, the land was the site of a former gas station, dairy, or dry cleaners, etc.) Unfortunately, accepting the land also results in accepting the liability for cleaning up the mess. A good contribution policy could help prevent this from happening by requiring all gifts of property be approved by the appropriate committee prior to acceptance. Contribution acceptance is just one of the topics to be included in a policy manual. Here are a few more.
Offering counting, recording and reporting
Bill approval and payment
Financial statement presentation
Personnel and employee benefits
Conflicts of interest
Building and property use
Short-term mission trips
KEY: A church accounting and management policies and procedures document is another brick in the wall of risk management. The goal of establishing clear policies is to anticipate problems before they arise and having a suitable response should they occur.
Operating without an annual budget
In fairness, there are very few churches that do not have some form of budget. The key words in this caption are “operating without”. The main point here is that even though most churches do have some type of budget written on paper, far too many operate as if they did not have one or misuse the one they do have.
Historically, church budgets have had a two-fold purpose.
First, they fill a financial role helping to make sure the church stays within acceptable and approved spending parameters.
KEY: The pendulum swings pretty wide in regard to church mismanagement of budgets. Some churches completely ignore the budget once it is approved begging the question, “Why have one to begin with?”
Other churches let their budget become a straight jacket, leading to some unfortunate results:
“Stingy” finance committee/team members may refuse to allow their church to begin new ministries because “This is not in the budget!” I have seen situations where churches have missed out on great ministry opportunities because they “postponed” them until the end of the year when the new venture could “be budgeted”. This in spite of the fact that the church had ample cash in reserve to fund the new project.
Occasionally a church staff may be intimidated by finance team members and are fearful of overspending a budget line item. But, due to their belief that a project is essential, go ahead and authorize expenditures. To cover their tracks, the expenditures are not included in the budget but are classified to other less visible areas, such as designated funds or the church’s net asset account (retained earnings). The budget report is unaffected making it appear that the church “made budget”. Too much of this type of activity results in meaningless financial statements.
The church budget also has a spiritual role in that a church budget is simply the congregation’s vision for the coming year, stated in dollars.
KEY: This is particularly important in the establishment of your chart of accounts. A church’s chart of accounts should reflect its ministry. What your church management software representative suggests is just that; a suggestion. The same goes for your CPA
The AICPA CPA Letter Daily reported that companies that receive payments from credit cards or third-party settlement agencies may have to keep an eye out for 1099-K forms this year. These forms will be sent to businesses that receive more than $20,000 in gross payments from at least 200 transactions annually. Companies that receive both a 1099-K and a 1099-MISC should make sure their income wasn’t reported twice.
That’s great advice, but how does that apply to churches? Under this new reporting under the tax code, it is likely that churches who receive donations via credit card will receive a 1099-K from their merchant. However, as a tax-exempt organization (automatic for religious institutions), there is no further reporting requirement for churches. Nonprofits who file a 990 and taxable entities will report the information from 1099-K on their respective tax return, but this new regulation doesn’t change the fact that churches are exempt from filing a 990.
Thankfully, this new requirement will have very little impact on churches. But the tax laws change frequently, so it pays to stay informed. Subscribe to our updates by entering your email address in the box to the left so you don’t miss a thing!
Have other church tax questions? Add your comment below.
-Bryan Baughman, CPA, Church and Ministry Principal at PSK, LLP
Avoidance means to succeed in keeping away from something dangerous or undesirable. Conversely, the opposite of avoid is to confront. In church administration, the only way to avoid dangerous situations is to proactively confront, or face down, certain ideas, attitudes and practices within the church. In doing so, an administrator’s life as a church leader can be a positive experience due to the fact that more time will be spent focusing solely on administration, not being a fireman.
In this next series of blog posts we are going to spend our time discussing ten traps church business administrators should avoid. Or, stated positively, ten areas in which the administrator must be proactive in order to face down danger. The first of the ten is planning.
Trap #1 Operating without a plan
When my son and daughter were young we often went to Chuck E Cheese, a restaurant catering to kids, which specialized in pizza, clowns and games. One of their favorite games was Whac-a-Mole, the object of which was to score points by clubbing moles (mechanical not real!) over the head as they popped their heads out of holes. Many churches follow the Whac-a-Mole management theory. When “the tyranny of the urgent” kicks in, issues tend to be addressed as they pop-up. This method, such as it is, leads to many unpleasant results:
- The inability to make good decisions
- The inability to report reliable results of ministry activities
- The loss of credibility of leadership
- The loss of faith by the congregation in leadership’s ability to guide the church.
KEY: In the worst case scenarios the result can be fraud. Fraudsters do not like baselines. (More importantly, they do not like to be caught!) Baselines help establish what is normal within an organization. With no processes or plans in place, baselines cannot exist and a church will never know what normal is. A thief can swoop in, help himself to what he wants, and no one will be the wiser.
In our discussion of this particular “must to avoid”, we will break the planning process into two parts.
- Short-term planning
- Long-range planning
In our next post we will begin with a discussion of short-term planning